Puerto Rico: Information on How Statehood Would Potentially Affect Selected Federal Programs and Revenue Sources
Released: 2014-03-31T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: Puerto Rico has access to many federal programs, and is subject to certain federal tax laws; however, for some programs and for some aspects of tax law, Puerto Rico is treated differently than the states. Options for Puerto Rico's political status include statehood.

GAO was asked to review potential fiscal implications for federal programs if Puerto Rico were to become a state. This report examines potential changes to selected federal programs and related spending changes, and changes to selected federal revenue sources that would be expected should Puerto Rico become a state. This report also discusses economic and fiscal factors under statehood that could influence changes in spending and revenues.

To evaluate potential changes to selected federal programs and revenue sources, GAO reviewed federal laws and regulations and interviewed federal and Puerto Rico agency officials. To discuss factors that could influence changes in spending and revenue, GAO reviewed economic data from Puerto Rico's government and interviewed officials from the current and past Puerto Rico government administrations.

section_title: What GAO Found
paragraphs: Of the 29 federal programs GAO reviewed (which accounted for about 86 percent of federal program spending for states or their residents in fiscal year 2010), statehood would likely affect 11 programs. For 3 other programs, while the programs themselves would likely not change under statehood, eligibility determinations for these programs could be affected indirectly by changes that could occur to benefits in other programs. Statehood would not likely affect the 15 remaining programs. See figure below.

The extent to which federal spending would change for some of the programs affected by Puerto Rico statehood depends on various assumptions: these assumptions include the program eligibility options Puerto Rico might select or the rates at which eligible residents might participate in the programs. For example, for the four largest programs for which federal spending likely would change under statehood—Medicare, Medicaid, the Supplemental Nutrition Assistance Program (SNAP), and Supplemental Security Income (SSI)—GAO used various assumptions to estimate the range of potential effects on federal program spending. The estimated ranges for the four programs, as described below, are based on Puerto Rico being treated the same as the states in either 2010 or 2011, based on the year for which GAO had the most recent data.

Medicare: In fiscal year 2010, actual federal Medicare spending in Puerto Rico was $4.5 billion; if Puerto Rico had been a state in calendar year 2010, estimated federal spending would have ranged from $4.5 billion to $6.0 billion. The Medicare estimates take into account certain changes under the Patient Protection and Affordable Care Act occurring after 2010 that would reduce spending. Also, the Medicare estimates depend on the estimates for Medicaid, as some individuals are eligible for both programs.

Medicaid: In fiscal year 2011, actual federal Medicaid spending in Puerto Rico was $685 million; if Puerto Rico had been a state in calendar year 2011, estimated federal spending would have ranged from $1.1 billion to $2.1 billion. The Medicaid estimates do not take into account the cost of nursing home and home health services in Puerto Rico due to the lack of available cost data, and because Puerto Rico lacks an infrastructure of nursing home facilities, according to Centers for Medicare & Medicaid Services officials. If these services became available, Medicaid spending would likely increase.

SNAP: In fiscal year 2011, actual federal spending for a similar program in Puerto Rico was $1.9 billion; if Puerto Rico had been a state in calendar year 2011, residents would have been eligible for SNAP, and estimated federal spending would have ranged from $1.7 billion to $2.6 billion. One reason why the low end of the estimate range is less than actual spending is because participants' benefits would be reduced because of benefits received from SSI, for which Puerto Rico residents would newly qualify.

SSI: In fiscal year 2011, actual federal spending for a similar program in Puerto Rico was $24 million; if Puerto Rico had been a state in calendar year 2011, residents would have been eligible for SSI, and estimated federal spending would have ranged from $1.5 billion to $1.8 billion.

All the federal revenue sources GAO reviewed—individual and corporate income taxes, employment tax, excise tax, estate and gift taxes, and customs duties—could be affected if Puerto Rico became a state. For example, under statehood, Puerto Rico residents would be subject to federal tax on all their income: currently, they are subject to federal tax only on income from sources outside of Puerto Rico. Also, some sources of income, such as pension income, are taxed differently in Puerto Rico than in the states. As a result, for 2010, Puerto Rico filers' adjusted gross income for federal tax purposes would have been higher than that for Puerto Rico tax purposes. For some revenue sources, the extent to which federal revenue would change depends on various assumptions. For example, for the two largest revenue sources that would be affected substantially by statehood—individual and corporate income taxes—GAO used various assumptions to estimate a range of federal revenue. The estimate ranges, as described below, are based on Puerto Rico being treated the same as the states in either 2009 or 2010, based on the year for which GAO had the most recent data.

Individual income tax: In 2010, Puerto Rico taxpayers reported paying $20 million to the United States, its possessions, or foreign countries. According to officials from Puerto Rico's Department of Internal Revenue, most of these payments would have been to the United States. If Puerto Rico had been a state in 2010, estimated individual income tax revenue from Puerto Rico taxpayers would have ranged from $2.2 billion to $2.3 billion (after accounting for estimated payments in excess of tax liability from refundable tax credits, such as the earned income tax credit).

Corporate income tax: In 2009, U.S. corporations paid about an estimated $4.3 billion in tax on income from their affiliates in Puerto Rico. Most of this amount was from an unusually large amount of dividends repatriated from Puerto Rico (compared to amounts repatriated in earlier years or in 2010). Absent that spike in dividends, the federal taxes these corporations would have paid for 2009 would have been about $1.4 billion. If Puerto Rico had been a state in 2009, estimated corporate income tax revenue from businesses that filed a Puerto Rico tax return for that year (or their parent corporations in the United States) would have ranged from $5.0 to $9.3 billion. The low end of this range assumes that U.S. corporations would have used prior-year losses of affiliated Puerto Rico corporations to offset their federal taxable income to the maximum extent (leaving only smaller or newly generated losses available to offset income in subsequent years), among other assumptions. However, this range does not take into account any behavioral changes of businesses with activities in Puerto Rico. For example, according to tax policy experts at the Department of the Treasury and the Joint Committee on Taxation, changes in federal income tax requirements under statehood would likely motivate some corporations with substantial amounts of income derived from intangible (and therefore mobile) assets to relocate from Puerto Rico to lower tax foreign locations. The extent to which such corporations might relocate from Puerto Rico is unknown. Consequently, GAO produced an alternative set of revenue estimates to account for some businesses with activities in Puerto Rico potentially relocating under statehood: this range was -$0.1 billion to $3.4 billion. The low end of this range is negative because U.S. corporations would have used their Puerto Rico affiliates' prior-year losses to reduce their taxes to such an extent that they would have more than offset the positive tax amounts that other corporations continuing to operate in Puerto Rico under statehood would have paid.

Puerto Rico faces various economic and fiscal challenges that could potentially impact changes in federal spending and revenue under statehood. For example, its economy largely has been in recession since 2006, and its levels of employment and labor force participation are relatively low, compared to those of the states. Persistent deficits have resulted in an increase in Puerto Rico's public debt, which represents a much larger share of personal income than in any state (and in February 2014, Puerto Rico's general obligation bonds were downgraded to speculative—noninvestment—grade by three ratings agencies). Puerto Rico has taken recent steps to improve its fiscal position, such as reducing its government workforce and reforming its largest public employee retirement system. Changes in federal program spending and to federal tax law under statehood could lead to economic and fiscal changes of their own in Puerto Rico. That may have a cascading effect on federal spending and revenue levels. However, the precise nature of such changes is uncertain. Because statehood would cause numerous adjustments important to Puerto Rico's future, it would require careful consideration by Congress and the residents of Puerto Rico. Consequently, statehood's aggregate fiscal impact would be influenced greatly by the terms of admission, strategies to promote economic development, and decisions regarding Puerto Rico's government revenue structure.

section_title: What GAO Recommends
paragraphs: GAO is not making recommendations. Federal agency and Puerto Rico government officials reviewed GAO's draft report; their comments were incorporated as appropriate.

To view the Spanish translation of this highlights page, please see GAO-14-301 .

section_title: Letter
paragraphs: In some ways, Puerto Rico—the largest and most populous territory of  the United States—has a fiscal relationship with the federal government  similar to that with the states. For example, Puerto Rico’s residents have  access to many federal programs and are subject to certain federal tax  laws. However, for some federal programs, Puerto Rico or its residents  are subject to different requirements or funding rules than are the states  or their residents. Likewise, some federal tax laws apply differently to  Puerto Rico residents and corporations than to residents of the states and  corporations in the states.

Puerto Rico’s political status has been debated for over a century. The  policy of the federal executive branch has long been that Puerto Rico’s  status should be decided by the people of Puerto Rico (although  Congress has ultimate authority over the admission of states). To that  end, since the 1960s, Puerto Rico has held four plebiscites intended to  determine its preferred status relationship with the United States, most  recently in 2012. Statehood has been one of the status options included  in those plebiscites.relations between it and the federal government would likely change.

If Puerto Rico were to become a state, fiscal  You asked us to review the potential fiscal implications for federal  programs if Puerto Rico were to become a state. The objectives of this  report are to evaluate (1) potential changes to selected federal programs  and related changes in federal spending, and (2) potential changes to  selected sources of federal revenue, should Puerto Rico become a state.  We also describe factors under statehood that could influence changes in  federal spending and revenue, such as the effect of statehood on Puerto  Rico’s economy and public finances.

To evaluate potential changes to selected federal programs under Puerto  Rico statehood, we used data from fiscal years 2010 and 2011 to identify  programs that generally provide funds directly to states and territories, or  residents and institutions in the states and territories.programs, we identified those that had total federal net outlays of at least  $5 billion and/or programs for which federal spending in Puerto Rico  differed by at least $100 million from spending in a set of comparable  states. Based on these criteria, we selected 29 programs to review, which  accounted for about 86 percent of spending in fiscal year 2010 on  programs that generally provide funds directly to states and territories, or  residents and institutions in the states and territories.

For each selected program, we reviewed relevant laws and regulations  and interviewed federal (and in some cases Puerto Rico) agency officials  to determine if and how spending would change under Puerto Rico  statehood. For some programs, current law applies certain limitations or  exceptions to Puerto Rico by name. For other programs, the governing  statutes refer to the 50 states or the 50 states and the District of  Columbia. For these programs, we assumed that if Puerto Rico became a  state, it would be treated the same as any existing state, either because  Congress would amend the statutory limitations and exceptions or  because they would otherwise not apply.

To evaluate potential changes in federal spending that could result from  potential changes to federal programs, we developed estimates of federal  spending under statehood for some programs. The programs for which  we developed estimates accounted for about 94 percent of fiscal year  2010 spending on programs that would likely change under statehood.  For these programs, we developed a range of estimated spending for a  single year in the past, as if Puerto Rico had been treated like the other  states in that year.based on the data available when we began our work. The estimates are  based on various assumptions—such as the program eligibility options  Puerto Rico might select or the rates at which eligible residents might  participate in the programs—which are described in detail for each  program in appendix II.

The year of the estimate ranges vary by program,  To evaluate potential changes to selected federal revenue sources under  Puerto Rico statehood, we reviewed federal laws and regulations related  to the main sources of federal revenue in fiscal year 2012—individual  income tax (which accounted for 46.2 percent of federal revenue in fiscal  year 2012), employment tax (34.5 percent), corporate income tax (9.9  percent), excise tax (3.2 percent), customs duties (1.2 percent), and  estate and gift taxes (0.6 percent).Puerto Rico’s Department of Internal Revenue and data from the Internal  Revenue Service to estimate potential changes in revenue for some  federal revenue sources.

We also used tax return data from  To identify factors under statehood that could influence changes in  federal spending and revenue, we reviewed economic data from Puerto  Rico’s government. We also reviewed reports on Puerto Rico’s economy,  such as those from the Federal Reserve Bank of New York and the  Congressional Budget Office. We also interviewed officials from the  current and past Puerto Rico government administrations and Puerto  Rico business associations representing large economic sectors in Puerto  Rico to obtain their views on the potential impacts of statehood on Puerto  Rico’s economy and public finances.

We took various steps to assess the reliability of the data we used to  select programs to evaluate and to estimate changes in spending and  revenue. For example, we reviewed available documentation, examined  the data for questionable or inconsistent values, and interviewed federal  and Puerto Rico agency officials, as appropriate, to understand the data  that we used. We also assessed the reliability of the Urban Institute’s  modeling procedures by reviewing documentation on the models and  input data sources, discussing the program rules and underlying  assumptions used in the models with staff from the Urban Institute who  were responsible for the work provided under our contract, and reviewing  the Urban Institute’s internal quality control procedures. We determined  that the data used in the report, as well as the Urban Institute’s modeling  procedures were sufficiently reliable for the purposes of this report.

The estimates involve various sources of uncertainty. Some estimates of  federal spending are based, in part, on sample survey data, which  required us to take sampling error into account. Unless otherwise  indicated, the margin of error for estimates using sampling survey data is  plus or minus 7 percent, or less, of the estimates themselves. There are  other sources of uncertainty that are not readily quantifiable. These  include the assumptions we used to develop the estimates, such as those  for which program eligibility rules Puerto Rico would adopt and the rates  at which eligible Puerto Rico residents would participate in the programs.  To some extent, the various scenarios for estimated spending and  revenue that we include capture the extent to which these assumptions  would impact spending and revenue. In other instances, there may be  sources of uncertainty and dynamic changes under statehood that we  could not incorporate into our modeling. These could include further  changes in eligibility rules once additional program funding becomes  available, the reaction of program beneficiaries to changes in the  programs, or changes in economic activity (and resulting revenue). For  additional details on our scope and methodology, see appendix I.

We conducted this performance audit from June 2012 to March 2014 in  accordance with generally accepted government auditing standards.

Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
subsections: section_title: Puerto Rico’s Political Status
paragraphs: Puerto Rico, with about 3.6 million residents, is the largest U.S. territory.  As a territory, Puerto Rico is subject to congressional authority, although  Congress has granted Puerto Rico authority over matters of internal  governance.

Puerto Rico has held 4 plebiscites intended to determine its preferred  status relationship with the United States. The most recent plebiscite,  held in November 2012, asked voters in Puerto Rico two questions: (1)  whether Puerto Rico should continue its present form of territorial status,  and (2) regardless of how voters answered the first question, which non- territorial status option is preferred—statehood, independence, or a  sovereign free associated state. For the first question, about 54 percent of voters indicated that Puerto Rico should not continue its present form  of territorial status. For the second question, about 61 percent of voters  who chose a non-territorial status option chose statehood.

The Consolidated Appropriations Act, 2014 includes $2.5 million in  funding for objective, nonpartisan voter education about, and a plebiscite  on, options that would resolve Puerto Rico’s future political status.  The  funds are to be provided to the State Elections Commission of Puerto  Rico.

section_title: Federal Payments to and Revenue from Puerto Rico
paragraphs: Congress generally determines whether Puerto Rico is eligible for federal  programs on a case-by-case basis, and defines any different treatment in  law. For example, federal programs in Puerto Rico may be subject to  certain funding or eligibility restrictions. For some programs, current law  applies certain limitations or exceptions to Puerto Rico by name. For  other programs, the governing statutes refer to the 50 states or the 50  states and the District of Columbia.

Where differences are not mandated by law, federal agencies generally  treat Puerto Rico the same as the states. Yet, characteristics of federal  programs in Puerto Rico may differ from the states for other reasons. For  example, a study by the U.S. President’s Task Force on Puerto Rico’s  Status found that governments and organizations in Puerto Rico were not  applying for and seeking all available federal funds. It also found that a  significant amount of funds available in Puerto Rico are not spent in a  timely manner.

Pub. L. No. 113-76, 128 Stat. 5, 61 (2014). exempt from federal taxes on income from Puerto Rico sources.differences contribute to Puerto Rico and its residents receiving fewer  federal payments, and paying less in federal tax, than residents of the  states on a per capita basis, as shown in figure 1.

section_title: Puerto Rico’s Economy
paragraphs: Historically, trends in Puerto Rico’s economy have tended to follow those  in the rest of United States. However, Puerto Rico’s latest economic  downturn has been longer and more extreme than the mainland U.S.  downturn. Specifically, the U.S. economy entered into a recession in  December 2007, which ended in June 2009, according to the Business  Cycle Dating Committee of the National Bureau of Economic Research.  In contrast, Puerto Rico’s recession began in the fourth quarter of 2006,  and the economy contracted every fiscal year from 2007 to 2011. After  growth of 0.1 percent in fiscal year 2012, the economy is projected to  have contracted in fiscal year 2013 by 0.4 percent, according to the  Government Development Bank for Puerto Rico.

section_title: Puerto Rico’s Fiscal Position
paragraphs: Recently, Puerto Rico’s government has faced various fiscal challenges,  including an imbalance between its general fund revenues and  expenditures. In fiscal year 2009, Puerto Rico’s fiscal deficit reached a  high of $2.9 billion—based on $7.8 billion in revenues and $10.7 billion of  expenditures. Persistent deficits have resulted in an increase in Puerto  Rico’s public debt, which represents a much larger share of personal  income than in any of the states. In February 2014, Puerto Rico’s general  obligation bonds were downgraded to speculative—noninvestment— grade by three ratings agencies.

Recently, Puerto Rico has taken steps to improve its fiscal position.

Beginning in 2007, Puerto Rico began to reduce the size of its  government workforce. For example, between 2007 and 2009,  government employment declined almost 10 percent. However, as of  July 2012, government employment still accounted for a larger share  of overall employment in Puerto Rico when compared to the states  (although, government employment as a share of the population older  than 15 in Puerto Rico was similar to that in the states).

In 2009, a fiscal stabilization plan was put into effect that reduced  government spending and increased tax revenues.

In April 2013, Puerto Rico enacted comprehensive reform of its  largest public employee retirement system, which is funded primarily  with budget appropriations from the government’s general fund. The  reform was intended to address the retirement system’s deteriorating  solvency.

Through measures like these, Puerto Rico has reduced its annual deficits.  However, the fiscal year 2013 deficit was approximately $1.3 billion,  based on projected expenditures of approximately $10 billion. As the  Government Development Bank for Puerto Rico notes in its Financial  Information and Operating Data Report from October 2013, Puerto Rico’s  ability to continue to reduce its deficit will depend in part on its ability to  continue increasing revenues and reducing expenditures, which in turn  depends on a number of factors, including improvements in economic  conditions.

section_title: Potential Changes to Selected Federal Programs under Puerto Rico Statehood
paragraphs: Of the 29 selected federal programs we reviewed, statehood would likely  affect 11 programs. For 3 other programs, while the programs themselves  would likely not change under statehood, eligibility determinations for  these programs could be affected indirectly by changes that could occur  to benefits in other programs. Statehood would not likely affect the 15  remaining programs. Ultimately, changes to programs under statehood  would depend on decisions by Congress and, to some extent, on  decisions by federal agencies. For example, Congress could enact  legislation that creates or maintains certain exceptions for Puerto Rico.  Figure 3 shows whether and how statehood would potentially affect the  programs we reviewed. Additional details on programs that statehood  would likely affect appear in appendix II.

The extent to which federal spending would change for some of the  programs that would be affected by Puerto Rico statehood depends on  various assumptions, such as which program eligibility options Puerto  Rico might select, and the rates at which eligible residents might  participate in the programs. For example, for the four largest programs for  which federal spending would be likely to change under statehood— Medicare, Medicaid, SNAP, and SSI—and for the ninth largest program  for which federal spending would be likely to change—CHIP—GAO used  various assumptions to estimate a range of federal spending. Figure 4  below shows the range of estimated federal spending for these programs  based on these assumptions, which are described in detail for each  program in appendix II. Figure 4 also shows a Federal Highway  Administration estimate for federal spending for Federal-Aid Highways,  the fifth largest program for which federal spending would be likely to  change under statehood. The estimates were developed for a single year  in the past, as if Puerto Rico were treated the same as the states in the  year specified for each program. For programs other than Federal-Aid  Highways, the estimates are in calendar-year terms because the eligibility  and other data used to develop the estimates were in calendar-year  terms. The estimate for Federal-Aid Highways is in fiscal-year terms.  Actual spending in Puerto Rico, to which we compare the estimates, is in  fiscal-year terms because the spending data were reported in fiscal-year  terms.

section_title: Potential Changes to Selected Federal Revenue Sources under Puerto Rico Statehood
paragraphs: All the federal revenue sources we reviewed could be affected if Puerto  Rico became a state. As with our review of programs, we assumed that if  Puerto Rico becomes a state, it would be treated as such for purposes of  revenue collection. For example, under statehood, Puerto Rico residents  would be subject to federal tax on all their income: currently they are  subject to federal tax only on income from sources outside of Puerto  Rico. However, for two revenue sources through which Puerto Rico  receives revenue not provided to other states—excise taxes and customs  duties—whether or how statehood would result in changes would depend  on decisions by Congress. Figure 5 shows how the revenue sources we  reviewed potentially would change under statehood. Additional details on  the two largest revenue sources that would be affected substantially by  statehood—individual and corporate income taxes—appear after figure 5  and in appendix III.

The extent to which statehood would affect federal revenue depends on  various assumptions. For example, for the two largest revenue sources  that would be affected substantially by statehood—individual and  corporate income taxes—we used various assumptions to estimate a  range of federal revenue. The estimate ranges are based on Puerto Rico  being treated the same as the states in either 2009 or 2010, based on the  year for which the most recent data were available. An example of how  assumptions affect the estimates is illustrated by the estimate range for  corporate income tax. That estimate is influenced by assumptions on  applicable tax rates for business with activities in Puerto Rico, the extent  of ownership of Puerto Rico businesses by U.S. corporations, and the  extent to which U.S. corporations use prior-year losses from their  affiliated Puerto Rico businesses to offset their federal taxable income.   For example, the low end of the estimate range shown in figure 6 below is  based on lower-bound assumptions for applicable corporate income tax  rates, upper-bound assumptions for the extent of U.S. ownership of  Puerto Rico businesses, and the assumption that U.S. corporations would  have used prior-year losses of affiliated Puerto Rico corporations to offset  their federal taxable income to the maximum extent. The high end of the  estimate range shown in figure 6 is based on the upper-bound  assumptions for applicable tax rates, lower-bound assumptions for the  extent of U.S. ownership of Puerto Rico businesses, and the assumption  that U.S. corporations would not have used any prior-year losses of  affiliated Puerto Rico corporations to offset their federal taxable income.

The estimates for corporate income tax in figure 6 do not take into  account any changes in behavior of businesses with activities in Puerto  Rico. For example, according to tax policy experts at the Department of  the Treasury and the Joint Committee on Taxation, changes in federal  income tax requirements under Puerto Rico statehood are likely to  motivate some corporations with substantial amounts of income derived  from intangible (and therefore mobile) assets to relocate from Puerto Rico  to a lower tax foreign location. The extent to which such corporations  might relocate from Puerto Rico is unknown. Consequently, we produced  an alternative set of corporate income tax revenue estimates to account  for some businesses with activities in Puerto Rico potentially relocating  under statehood. Accounting for this assumption, in conjunction with the  other assumptions described previously, resulted in an estimated range of  corporate income tax revenue of -$0.1 billion to $3.4 billion.

section_title: Factors under Statehood that Could Influence Changes in Federal Spending and Revenue
paragraphs: Statehood could result in dynamic economic and fiscal changes for  Puerto Rico, changes that could ultimately impact the level of federal  spending in Puerto Rico, and the revenue collected from residents of, and  corporations in, Puerto Rico. However, the precise nature of how such  changes would affect federal spending and revenue is uncertain.  Because statehood would cause numerous adjustments important to  Puerto Rico’s future, it would require careful consideration by Congress  and the residents of Puerto Rico. Consequently, statehood’s aggregate  fiscal impact would be influenced greatly by the terms of admission,  strategies to promote economic development, and decisions regarding  Puerto Rico’s revenue structure. As we have reported in the past, the  history of statehood admissions is one of both tradition and flexibility.  While Congress has emphasized the traditional principles of democracy,  economic capability, and the desire for statehood among the electorate, it  has also considered potential states’ unique characteristics, including  population size and composition, geographic location, economic  development, and historical circumstances when making these decisions.  Any decision to transition Puerto Rico to statehood in the future will also  involve assessing a complex array of similar factors, in addition to  economic and fiscal ones. Some factors that could influence changes in  federal spending and in revenue for specific programs or types of tax are  discussed in appendix II and appendix III of this report. In this section, we  discuss general factors that could influence how Puerto Rico statehood  could affect future federal spending and revenue.
subsections: section_title: Effect of Statehood on Puerto Rico’s Economy and Employment
paragraphs: As previously discussed, Puerto Rico’s economy has largely been in  recession since 2006. Likewise, Puerto Rico’s unemployment rate has  been relatively high, and its labor force participation rate has been  relatively low, compared to those of the states. Statehood—and the  resultant changes to spending programs in Puerto Rico, and in tax  requirements for Puerto Rico residents and corporations—could have  wide-reaching effects on Puerto Rico’s economy and employment.

Under statehood, Puerto Rico residents would be eligible for the federal  earned income tax credit (EITC)—including refundable payments—which  is designed to encourage work. Also, in the short-term, increased  federal transfers—such as through SSI benefits, which Puerto Rico  residents would become eligible for under statehood—could stimulate  Puerto Rico’s economy. However, some Puerto Rico industry group  representatives we interviewed worried that the relatively high rate of  government transfer payments in Puerto Rico could discourage work.  According to the Federal Reserve Bank of New York, such transfer  payments equate to roughly 40 percent of personal income, more than  double the share in the states.

Likewise, the effect of statehood on Puerto Rico migration—and the  corresponding effect of that migration on Puerto Rico’s economy and  employment—is uncertain. From 2002 to 2012, Puerto Rico’s population  decreased by about 5 percent based on U.S. Census Bureau estimates. Migration has been cited as a possible explanation for Puerto Rico’s  relatively low labor force participation rate, particularly if those Puerto  Rico residents most interested in participating in the labor force are  migrating to the states in search of higher wage employment, leaving  behind residents that have relatively less attachment to the labor force.

From 2002 to 2012, population in the states increased by 9.1 percent, and decreased in  only 2 states—Rhode Island and Michigan (by 1.5 percent in both states)—based on U.S.  Census Bureau estimates. various factors corporations generally take into account when determining  where to locate their operations). Also, local businesses could incur  higher costs because of additional tax liabilities.

section_title: Effect of Statehood on Puerto Rico’s Public Finances
paragraphs: As previously discussed, Puerto Rico has run persistent fiscal deficits in  recent years, which has increased Puerto Rico’s public debt. As a result,  Puerto Rico government-issued debt represents a much larger share of  personal income than in any of the states. Recently, Puerto Rico has  taken steps to improve its fiscal position, including reducing the size of its  government workforce and reforming its primary public employee  retirement system. However, in February 2014, Puerto Rico’s general  obligation bonds were downgraded to speculative—noninvestment—  grade by three ratings agencies, in part because of concerns about  Puerto Rico’s fiscal position.

One factor that may have facilitated Puerto Rico’s ability to issue debt is  that the interest on most bonds issued by Puerto Rico’s government, its  political subdivisions, and its public corporations generally is not subject  to income tax at the federal, state, or local levels. Under statehood, if  Puerto Rico was treated like the states, its government-issued debt would  no longer enjoy this so called triple-exemption, as income accruing to  residents of other states would become taxable at the state and/or local  levels. The loss of triple-exempt bond status could result in reduced  demand for Puerto Rico’s debt.

The $152 million estimate is subject to a high level of statistical imprecision, with a  margin of error of plus or minus 14.5 percent of the estimate itself. tax burdens for individuals and corporations, it would need to lower its tax  rates, which could reduce tax revenue.

section_title: Effect of a Statehood Transition Period
paragraphs: Under statehood, certain federal programs in Puerto Rico could change  substantially if Puerto Rico were treated the same as the states. Likewise,  Puerto Rico residents and corporations operating in Puerto Rico would  become subject to significant changes in their tax requirements under  statehood. Prior bills on Puerto Rico’s status that Congress has  considered have included provisions providing for a transition period or  plan. Under one approach, if Puerto Rico were to become a state,  federal funding would increase incrementally until parity with other states  was reached, and federal income tax requirements would be phased in.

If Congress granted statehood to Puerto Rico, it could decide to establish  a similar transition period. In turn, the characteristics and length of time of  such a transition period could affect federal spending and revenue  during—and beyond—that period.

section_title: Agency and Puerto Rico Government Officials Comments
paragraphs: We provided draft sections of this report to the relevant federal program  agencies, the Department of the Treasury, and IRS. We also shared a  draft of the report with officials from the Government of Puerto Rico and  the Resident Commissioner from Puerto Rico (Puerto Rico’s  Congressionally-authorized representative in Washington, D.C.).

In total, we sent draft report sections to 16 federal agencies.agencies had no comments on their draft report sections. Ten agencies  provided technical comments, which we incorporated as appropriate. We  also received technical and written comments from the Governor of  Puerto Rico and the Resident Commissioner from Puerto Rico. Technical  comments were incorporated as appropriate; the written comments are   Six  reproduced as appendix V (Governor) and appendix VI (Resident  Commissioner) to this report.

In his written comments, the Governor of Puerto Rico noted that if we had  considered two factors omitted from our estimate of individual income tax  revenue under statehood, estimated revenue would have been higher.  First, the Governor noted that different federal filing thresholds and tax  rates, compared to those for Puerto Rico, would have resulted in more  individuals subject to tax and an increased amount of federal taxes paid  by individuals. Our individual income tax revenue estimates take these  differences into account, as they are based on the federal filing thresholds  and federal tax rates. That is to say, we were able to determine which  Puerto Rico residents who filed a Puerto Rico tax return for 2010 would  have met federal filing thresholds and what tax rates would have applied  to their taxable income, if at all. The Governor also noted that Puerto Rico  does not tax Social Security benefits, which may be taxable at the federal  level. In the individual income tax section of appendix III to this report, we  note that because Social Security benefits are not included on Puerto  Rico tax returns, our estimates do not take taxable Social Security  benefits into account, and as a result our estimates could understate  individual income tax revenue.

In response to our estimate for corporate income tax revenue, the  Governor noted that to counter the effect of increased taxes on Puerto  Rico businesses upon the imposition of federal taxes, our draft report  suggested that Puerto Rico would reduce its corporate tax rate to 3.8  percent to be on par with the average corporate tax rate in the states  (state taxes are deductable against corporate income for federal tax  purposes). He noted that this assumption is unrealistic given Puerto  Rico’s current level of corporate tax rates and Puerto Rico’s current fiscal  situation. We based our modeling of corporate income tax revenue under  statehood on the assumption that Puerto Rico would lower its corporate  tax rates to be more in line with those in the states. However, we used the  average effective rate in the states, which is different than a simple   Based on this comment, we conducted a sensitivity  marginal rate.analysis to determine how our estimates would change if we assumed  that the effective rate of Puerto Rico’s corporate income tax under  statehood would have been twice as high as the average effective state  rate (an effective rate of 7.6 percent). We found that the estimate ranges  would not have changed substantially using this alternative assumption.

Finally, the Governor noted that the characterization in the draft report of  the percent of votes received by statehood in the 2012 plebiscite is  inaccurate, and that the report should explain further the structure and  outcomes of the plebiscite. In response to this comment, we provided  additional detail on the number of voters and blank votes for both  questions from the plebiscite. Assessing the structure of the plebiscite is  outside the scope of this report.

In his written comments, the Resident Commissioner for Puerto Rico  summarized the central findings of the draft report. He also pointed out  some of the uncertainties and limitations inherent in developing estimates  for how federal spending and revenue would change if Puerto Rico  became a state, which we recognize in the report.

As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the heads of the relevant  agencies for the programs and revenue sources in this report, Puerto  Rico’s governor, the Resident Commissioner for Puerto Rico, appropriate  congressional committees, and other interested parties. In addition, the  report will be available at no charge on the GAO website at  http://www.gao.gov.

If you or your staff members have any questions about this report, please  contact me at (202) 512-6520 or at czerwinskis@gao.gov. Contact points  for our Offices of Congressional Relations and Public Affairs may be  found on the last page of this report. GAO staff who made key  contributions to this report are listed in appendix VII.

section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: The objectives of this report are to evaluate (1) potential changes to  selected federal programs and related changes in federal spending, and  (2) potential changes in selected sources of federal revenue, should  Puerto Rico become a state. We also describe factors under statehood  that could influence changes in federal spending and revenue.
subsections: section_title: Potential Changes to Selected Federal Programs and Related Changes in Federal Spending
paragraphs: To evaluate potential changes in selected federal programs under Puerto  Rico statehood, we selected programs to review based on three criteria.

Programs that generally provide funds directly to states and  territories, or residents and institutions in the states and  territories. Based on this criterion, we excluded certain types of  federal spending from our review. Specifically, we excluded spending  on the military;debt; and administrative, operational, procurement, or capital  acquisition expenses at federal agencies, including federal employee  salaries and retirement compensation.   international aid and affairs; interest on the national

Programs with net outlays of at least $5 billion. We used the  Office of Management and Budget (OMB) public budget database  from fiscal years 2010 and 2011 to select programs to review. We  identified budget accounts with at least $5 billion, and then reviewed  the programs within each account to identify those with outlays of at  least $5 billion. We defined a program as an organized set of  activities with the same objective(s) and funded by the federal  government. We focused on programs that are expected to have an  ongoing impact on the federal budget, meaning we did not consider  temporary funding, such as that provided under the American  Recovery and Reinvestment Act of 2009. To further support whether  the programs met our selection criteria, we compared programs with  total federal outlays of at least $5 billion (from the OMB database) to  those described in the Catalog of Federal Domestic Assistance and  the Appendix to the Budget of the U.S. Government. Through this  process, we identified 27 programs to review.

Programs for which federal spending in Puerto Rico differed  significantly from spending in a set of comparable states. To  identify programs with less than $5 billion in net outlays that may be  subject to relatively large spending changes under statehood—such  as those providing little or no funding to Puerto Rico—we reviewed  federal program spending by state from the Census Bureau’s  Consolidated Federal Funds Report for fiscal year 2010. We selected  five states most similar to Puerto Rico in terms of population and  median household income, and identified programs for which the  difference in average federal spending between these states and  Puerto Rico was at least $100 million. Through this process, we  identified two additional programs to review: the Public Housing  Operating Fund and the Public Housing Capital Fund.

The 29 programs we selected to review accounted for about 86 percent of  spending in fiscal year 2010 on federal programs that generally provide  funds directly to states and territories, or to residents and institutions in  the states and territories.

We asked the 12 federal agencies that administer the 29 programs we  selected to review our selection methodology and confirm that inclusion of  each program was appropriate based on our criteria. The agencies  provided additional information and documentation, when necessary. In  one instance, a selected program comprised a subset of a larger budget  account, and the agency overseeing the program was unable to provide a  net outlay figure.programs, we report obligation amounts for the 29 programs we selected  for our review, as obligation amounts were available for all selected  programs (see figure 3 earlier in this report).

To consistently report federal spending across  For each selected program, we reviewed federal laws and regulations to  determine whether and how statehood might affect funding or other  requirements for Puerto Rico. We based our analyses on the assumption  that, if it is granted statehood, eventually Puerto Rico would be treated  the same as the states. For some programs, current law applies certain  limitations or exceptions to Puerto Rico by name. For other programs, the  governing statutes refer to the 50 states or the 50 states and the District  of Columbia. For these programs, we assumed that, if Puerto Rico  became a state, it would be treated the same as any existing state, either  because Congress would amend the statutory limitations and exceptions  or they would otherwise not apply. We did not evaluate whether Puerto  Rico would be required to be treated the same as the states in the context  of any specific program. We confirmed with the relevant agencies  whether and how statehood would affect funding or other requirements  for Puerto Rico.

To evaluate potential changes in federal spending related to changes to  federal programs, we evaluated the five largest programs that would be  likely to change under statehood. We developed estimate ranges of the  potential changes in federal spending for the four largest programs that  would be likely to change under statehood: Medicare, Medicaid, the  Supplemental Nutrition Assistance Program (SNAP), and Supplemental  Security Income (SSI). The Federal Highway Administration developed an  estimate on our behalf of potential changes in federal spending for the  fifth largest program that would be likely to change under statehood— Federal-Aid Highways. We also developed an estimate of potential  changes in spending for the ninth largest federal program that would be  likely to change under statehood—the Children’s Health Insurance  Program (CHIP)—because Puerto Rico receives federal CHIP funding as  part of its Medicaid program. The programs for which we developed  estimates accounted for about 94 percent of fiscal year 2010 spending on  programs that would likely change under statehood. We developed  estimate ranges for a single year in the past, as if Puerto Rico had been  treated the same as the states in that year. The years of the estimate  ranges vary by program and are based on the most recent relevant data  when we began our work. For programs other than Federal-Aid  Highways, the estimate ranges are in calendar-year terms because the  eligibility and other data used to develop the estimates were in calendar- year terms. The estimate for Federal-Aid Highways is in fiscal-year terms.  Actual spending in Puerto Rico, to which we compare the estimates, is in  fiscal-year terms because the spending data were reported in fiscal-year  terms.

To estimate potential changes in federal spending for Medicaid, SNAP,  SSI, and CHIP, we contracted with the Urban Institute to conduct portions  of the work using two simulation models. We also used aspects of the  Urban Institute’s simulations in estimating spending for Medicare.

The estimates of potential spending changes involve various sources of  uncertainty. Except for Federal-Aid Highways, the estimates are based, in  part, on sample survey data, which include sampling error. Sample  survey data are obtained by following a probability procedure based on  the selection of random samples, and each sample is only one of a large  number of samples that might have been selected. Since each sample  could have provided different estimates, sampling error measures the  level of confidence in the precision of a particular sample’s results, which  we express as a margin of error at the 95-percent confidence interval.  Unless otherwise indicated, the estimates included in this report that used  sample survey data—plus or minus 7 percent, or less, of the estimates  themselves—would contain the actual value for the populations we  analyzed for 95 percent of the samples that could have been selected.

There are other sources of uncertainty that are not readily quantifiable.  These include the assumptions we used to develop the estimates, such  as those for which program eligibility rules Puerto Rico would adopt, and  the rates at which eligible Puerto Rico residents would participate in the  programs. To some extent, the various scenarios for estimated spending  included in this report capture how these assumptions would impact  spending. In other instances, there may be sources of uncertainty and  dynamic changes to the programs that we could not incorporate into our  modeling. These could include further changes in eligibility rules once  additional program funding becomes available, the reaction of program  beneficiaries to changes in the programs, or congressional action  resulting from statehood.
subsections: section_title: Medicare Estimate
paragraphs: To estimate potential changes in federal spending for Medicare for 2010,  we estimated spending for the two options through which Medicare  beneficiaries can obtain insurance coverage for hospital and medical  services—Medicare fee-for-service (Medicare FFS) and Medicare  Advantage (MA), the private plan alternative to Medicare FFS—as well as  the optional prescription drug benefit.

For Medicare FFS, we first calculated average spending for various  demographic groups of Medicare beneficiaries in the states, using the  Centers for Medicare & Medicaid Services’s (CMS) Medicare Current  Beneficiary Survey (MCBS) Cost and Use file for 2010, the most recent  available at the time we began our work.information on Medicare beneficiaries, matched to administrative data on  actual spending. Using these data, we developed estimates for average  Medicare FFS spending by categories of age, gender, disability status,  and dual-eligible status—that is, beneficiaries eligible for both Medicare  and Medicaid. For some groups of Medicare beneficiaries, the MCBS  sample size allowed for finer age and gender group breakdowns; for  others, we combined age and gender groups.

To identify corresponding groups of Puerto Rico residents by age and  gender, we used data from the Census Bureau’s Puerto Rico Community  Survey (PRCS) three-year sample for 2009-2011: the years closest to the  year of the MCBS data we used. We also used estimates of dual- eligible beneficiaries that the Urban Institute developed. We calculated  the number of disabled but non-dual-eligible enrollees by subtracting the  number of dual-eligible enrollees and the number of enrollees over age  65 from the total number of enrollees. We multiplied the average  Medicare spending amounts from MCBS respondents in the states for  each group or category to the corresponding Puerto Rico beneficiary  count.

To account for different health care costs in Puerto Rico relative to the  states, we adjusted the wage indices used to calculate spending for  Medicare FFS Part A and the Geographic Practice Cost Indices used to  calculate spending for Medicare FFS Part B. We also made adjustments  to account for the lower Medicare FFS Part B take-up rate and lower  utilization rates in Puerto Rico relative to the states.

For MA, we used data from the MCBS file to estimate the average cost  for Puerto Rico MA enrollees. Because the benchmark underlying  payments to MA plans in Puerto Rico is changing (regardless of whether  Puerto Rico becomes a state) because of provisions in the Patient  Protection and Affordable Care Act (PPACA), we modeled spending  based on two benchmark scenarios: (1) the benchmark generally  applicable for Puerto Rico for fiscal year 2014 (147.5 percent), and (2) the  benchmark that generally will apply in 2017, when PPACA is fully phased- in (115 percent). Given that these changes in benchmarks could result in  Puerto Rico MA enrollees switching to Medicare FFS, we developed  estimates based on two MA enrollment scenarios: (1) the percentage of  Puerto Rico Medicare beneficiaries enrolled in MA in 2010 (about 64  percent), and (2) the highest MA enrollment percentage in the states  (about 42 percent). These changes are the only potential impacts of  PPACA we incorporated into our estimates for Medicare. For a  description of how PPACA could affect Medicare spending in Puerto Rico,  see appendix IV.

For the Medicare prescription drug benefit, we estimated the number of  enrolled beneficiaries by applying the percentage of Puerto Rico  beneficiaries who enroll in a benefit plan (77 percent) to our estimates of  Puerto Rico Medicare beneficiaries. Our estimates of Puerto Rico  Medicare beneficiaries include the estimates of dual-eligible beneficiaries  that the Urban Institute developed. We assumed that there would be  different costs per person depending on whether an enrolled beneficiary  was a dual-eligible beneficiary, a disabled but non-dual eligible  beneficiary, or any other beneficiary (essentially, all other enrolled  beneficiaries age 65 or older). Using MCBS data, we estimated average  prescription drug benefit costs for each of the three categories of  beneficiaries and applied those costs to the number of beneficiaries in  each category. We also assumed that the percentage of eligible Puerto  Rico Medicare beneficiaries who would have enrolled in the low-income  subsidy—which covers all, or a portion of, a beneficiary’s prescription  drug benefit plan premiums, deductibles, copayments, and other out-of- pocket costs—would have been the same as that for all Medicare  beneficiaries (about 77 percent).

We assessed the reliability of the PRCS and MCBS data by performing  appropriate electronic data checks, comparing MCBS data to  administrative data, and by interviewing CMS officials who were  knowledgeable about the data. We found the data were sufficiently  reliable for the purposes of this report.

section_title: Medicaid, SNAP, SSI, and CHIP Estimates
paragraphs: To estimate potential changes in federal spending for Medicaid, SNAP,  SSI, and CHIP, we contracted with the Urban Institute to conduct portions  of the work using two simulation models: (1) the Health Policy Center’s  American Community Survey Medicaid/CHIP Eligibility Simulation Model  (HPC Medicaid/CHIP model), and (2) the Transfer Income Model, Version  3 (TRIM3), which simulates major federal tax and transfer programs,  including SNAP, SSI, and Temporary Assistance for Needy Families  (TANF). For this work, these models used 2011 PRCS data and other  data sources to estimate the effect of program eligibility changes on the  number of eligible and enrolled individuals for a select program and, in  certain instances, they estimate the associated costs. We chose PRCS  as a data source because of its large sample size and detailed  information on the respondents’ demographics and participation in public  assistance programs. 2011 was the most recent available year of PRCS  data. We assessed the reliability of these data by reviewing available  documentation and conducting reliability tests on the data that we used.  We determined that the data were sufficiently reliable for the purposes of  this report.

We assessed the reliability of the Urban Institute’s modeling procedures  by reviewing documentation on TRIM3 and the HPC Medicaid/CHIP  model and input data sources, reviewing the Urban Institute's internal  quality control procedures, and discussing the program rules and  underlying assumptions used in the models with staff from the Urban  Institute who were responsible for the work provided under our contract.  Further, we evaluated the estimates on the basis of substantive  significance (rather than statistical significance) by considering their size  and the direction of the effect of changes to the programs under  statehood. We determined that none of the modeling assumptions  compromised the analysis for this report and that the data were  sufficiently reliable for our purposes.

Using the HPC Medicaid/CHIP model and TRIM3 to estimate spending  changes for these programs required our input on assumptions, and  about the rules governing federal programs. Therefore, the information  presented in this report is attributable only to GAO. Specific steps taken  to estimate spending for these programs appears below.

section_title: Medicaid
paragraphs: To estimate federal Medicaid spending for 2011, the Urban Institute used  the HPC Medicaid/CHIP model to estimate (1) the number of individuals  who would have been eligible for Medicaid, and (2) the number of eligible  individuals who would have enrolled in Medicaid. We then estimated (1)  total (federal and Puerto Rico) Medicaid spending, and (2) the federal  share of total Medicaid spending. We also estimated the extent to which  Puerto Rico’s spending on Medicaid would change.

The Urban Institute estimated eligibility based on our input for income  eligibility assumptions. To determine the most appropriate income  eligibility assumptions, we identified federal Medicaid mandatory  categories of individuals for states and Puerto Rico’s 2011 Medicaid  eligibility standards. We asked Puerto Rico officials for input on what  optional Medicaid income eligibility standards might be selected under  statehood. They told us that it would be difficult to determine what  optional coverage groups would be selected, given the significant  economic and budgetary restraints Puerto Rico currently faces, and  uncertainty around the cost to Puerto Rico of expanding coverage.  Ultimately, we chose to model two eligibility scenarios:

Assuming Puerto Rico would have covered only mandatory categories  of individuals. Under this scenario, Medicaid eligibility would have  increased for some categories (such as pregnant women and as well  as children). Optional categories (such as childless, non-elderly, non- disabled adults) would no longer be covered. This scenario represents  the lower bound of potential federal Medicaid spending under  statehood.

Assuming Puerto Rico would have covered mandatory categories of  individuals and expanded coverage levels for the optional categories it  actually covered in 2011.

For certain populations, such as pregnant women, infants, and children,  Medicaid eligibility is based on a family’s income level as a proportion of a  defined poverty level. Although Puerto Rico currently uses its own local  poverty level (see the section on Medicaid in appendix II), we assumed  that as a state, Puerto Rico would be required to adhere to the same  federal poverty guidelines as the 48 contiguous states and the District of  Columbia. We based this assumption, in part, on our general  assumption that Puerto Rico would be treated in the same manner as the  states, and on input from officials with the Department of Health and  Human Services’ Office of the Assistant Secretary for Planning and  Evaluation (ASPE). This office updates and publishes the annual federal  poverty guidelines.participation in federal programs, such as SSI, for which Puerto Rico  residents would become eligible under statehood.

For other populations, eligibility is based on  To estimate enrollments, we assumed that all actual Medicaid  beneficiaries and individuals estimated to have received SSI and TANF  benefits in 2011 would have enrolled. For all other eligible individuals,  we decided to apply participation rates observed for actual Puerto Rico  Medicaid and CHIP enrollees in the top decile of the distribution of  income-to-poverty ratio by subgroup (i.e., a matrix of age group,  insurance coverage, and disability status), based on the assumption that  newly eligible individuals would be more similar to higher-income eligible  individuals than to lower-income eligible individuals. The enrollment  estimates are by geographic region in Puerto Rico. The Urban Institute  also estimated the number of beneficiaries dually eligible for Medicare  and Medicaid.

To estimate total (federal and Puerto Rico) Medicaid spending, we  applied annualized per member per month rates paid for different  categories of enrolled individuals to estimated enrollments. The  annualized per member per month rates we used were those paid by  Puerto Rico to its managed care organization for Medicaid enrollees  between October 2010 and June 2011 for physical and mental health  services. These rates generally varied by geographical area and ranged  from about $1,180 to $1,852. For dual-eligible beneficiaries enrolled in  Puerto Rico’s Platino program—for whom the majority of health care  costs are covered by Medicare—the rate was $120. According to CMS  officials, the vast majority of beneficiaries enrolled in the Platino program  are dual-eligible beneficiaries. Thus, we used the Urban Institute’s  estimates for dual-eligible beneficiaries as a proxy for the number of  Platino enrollees when applying per person costs.

To estimate the federal share of total Medicaid spending, we applied a  predicted Federal Medical Assistance Percentage (FMAP)—the statutory  formula that determines the federal share of Medicaid funding provided to  states and territories—to total Medicaid spending. For Puerto Rico, the  predicted FMAP was 83 percent. We assumed that the statutory limit on  federal Medicaid funding to Puerto Rico would have been removed. We  also estimated Puerto Rico’s share of total Medicaid spending to show  how it would change under statehood.

We did not incorporate all aspects of the Medicaid program into our  spending model, including the cost of the Medicaid Disproportionate  Share Hospital (DSH) program or potential savings resulting from Puerto  Rico’s participation in the Medicaid drug rebate program. We did not  incorporate Puerto Rico’s Enhanced Allotment into our model, as it  would be likely eliminated under statehood and replaced with the  Medicare low-income subsidy for prescription drugs.

To estimate federal SNAP spending for 2011, the Urban Institute used  TRIM3 to estimate (1) the number of household units that would have  been eligible for SNAP benefits, (2) the number of eligible household  units that would have participated in SNAP, and (3) aggregate SNAP  benefits for participating household units.

The Urban Institute based its eligibility estimates on program eligibility  rules in the states (SNAP is currently unavailable to Puerto Rico  residents), including income and resource limits, and rules related to  participation in other means-tested programs, such as SSI and TANF.  The Urban Institute calculated net income by subtracting various  deductions from a household unit’s gross income—such as those for  earned income, dependent care expenses, medical care expenses,  excess shelter costs, and a standard deduction. Where the rules for  allowable deductions differ between (1) the 48 contiguous states and the  District of Columbia and (2) other states and territories, the estimates use  the rules applicable to the 48 contiguous states and the District of  Columbia. The Urban Institute imputed household units’ resources by  applying assumed annual rates of return on reported interest, dividends,  and rent.

To estimate the number of eligible household units that would have  participated in SNAP, we directed the Urban Institute to model four  different scenarios, based on the following assumptions on household  unit definitions and participation rates.

Everyone in a household would have filed for SNAP as a single unit,  unless the household contained at least one person who received  TANF. If the household contained a TANF recipient, it was divided  into as many filing units as possible, subject to the requirements  involving married couples and children. This household unit definition  was modeled using (1) a national probabilities estimate of SNAP  participation, resulting in a household participation rate of 75 percent,  and (2) full participation, which occurs in some states.

Assuming full participation, all related persons in a household would  have filed for SNAP as a single unit. Unrelated individuals and  subfamilies would have filed as separate units.

Assuming full participation, with households that had more than one  potential SNAP unit split into as many filing units as permitted.

For all scenarios, household units that reported receiving benefits under  Puerto Rico’s current federally-funded nutrition assistance program were  assumed to have chosen to participate in SNAP if they had qualified.

To estimate aggregate SNAP benefits for participating household units,  each participating household unit’s benefit amount was determined by  subtracting 30 percent of the household unit’s net income from the  maximum SNAP allotment for household unit size, using the maximum  SNAP allotments for the 48 contiguous states and the District of  Columbia. This reduction from the maximum SNAP allotments is made  because households are expected to spend 30 percent of their resources  on food. We also determined the impact on SNAP benefits of replacing  the Aid to the Aged, Blind, and Disabled (AABD) program with the higher- benefit SSI program, since an increase in cash aid could lower a person’s  SNAP benefits.

To estimate federal SSI spending for 2011, the Urban Institute used  TRIM3 to estimate (1) the number of individuals who would have been  eligible for SSI benefits, (2) the number of eligible individuals who would  have participated in SSI, and (3) aggregate SSI benefits for participating  individuals.

The Urban Institute based its eligibility estimates on program eligibility  rules for individuals’ age, blindness, or disability status, and income and  resource limits. To qualify for benefits based on age, an individual must  be at least 65 years old. Adults younger than 65 can qualify for benefits  based on blindness or a permanent disability that prevents work; children  can qualify based on a disability with conditions that severely limit their  activities. To determine disability status, doctors examine prospective  adult and child beneficiaries. Because the PRCS data do not precisely  capture the same criteria that are assessed by doctors, assumptions were  required to estimate potential SSI eligibility among the non-elderly. TRIM3  designated an adult as blind or disabled where the survey responses  showed (1) that the adult did not work in the prior year or earned income  less than the substantial gainful activity limit, and (2) at least one of the  following was true:

The adult indicated having a physical, remembering, or vision  limitation.

The adult was between 22 and 61 years old, not a widow, and  reported Social Security income.

TRIM3 treated children ages 15 and older as adults for the disability  eligibility determination since children are asked the same survey  questions asked of adults. TRIM3 identified children younger than 15 as  potentially disabled if they reported a remembering or vision disability.

The model was not used to estimate the number of children younger than  age 5 who were potentially disabled, because the remembering limitation  question is not asked of them. Instead a sufficient number of children  under age 5 were included so that the portion of the total children’s  caseload that is under age 5 is the same as in the states.

Regardless of age or disability status, individuals must have limited  assets and income to be eligible for SSI benefits. TRIM3 imposed the  eligibility asset test of $2,000 for a unit with one eligible person and  $3,000 for an eligible couple. Asset values were inferred from the level of  reported asset-based income (interest, dividend, and rental income).  Adults may qualify either individually or as couples. The simulation model  found that 81 percent of eligible adults were either unmarried or married  to an ineligible individual.

To estimate the number of eligible individuals who would have  participated in SSI, we present two scenarios—with participation rates  that varied by age group and disability status—assuming that eligible  individuals would participate based on (1) national average participation  rates, and (2) the average of participation rates for the five states with the  highest three-year average poverty rate for 2009 to 2011. For children  younger than 5, the data were not sufficient to estimate a participation  rate; instead, a sufficient number of children younger than 5 were  included so that their share of all eligible children was the same as in the  states. Individuals in the simulation determined to be participating in  AABD, which SSI would replace, were included as participating in SSI.

To estimate aggregate benefits, we used participant benefits following the  SSI program rules. To determine the actual benefit, the maximum SSI  benefits (in 2011, $674 for individuals and $1,011 for couples) were  reduced, based on countable income. In determining countable income,  SSI program rules disregard the first $20 of most income per month, plus  the first $65 of earned income and 50 percent of any additional earned  income. One-third of child support is also disregarded. For an individual  with a spouse who is not potentially eligible for SSI, the amount of the  spouse’s income to be deemed available is determined. For children,  some income is deemed from their parents.

To estimate federal CHIP spending for 2011, the Urban Institute used the  HPC Medicaid/CHIP model to estimate (1) the number of individuals who  would have been eligible for CHIP, and (2) the number of eligible  individuals who would have enrolled in CHIP. We then estimated total  (federal and Puerto Rico) CHIP spending.

The Urban Institute estimated eligibility based on our input on eligibility  rule assumptions. To qualify for federal CHIP funding, states’ CHIP  cannot cover children who are eligible for Medicaid. In 2011, states were  required to provide Medicaid coverage to children with family incomes up  to 100 percent and 133 percent of the federal poverty level (FPL),  depending on a child’s age. States have discretion in setting CHIP  eligibility standards. Forty-five states and the District of Columbia covered  children between 200 percent and 300 percent of the FPL in 2011.

Given required increases to Medicaid income eligibility limits under  statehood, Puerto Rico residents enrolled in CHIP in 2011 would have  qualified for Medicaid, but not for CHIP. To draw down federal CHIP  funding, Puerto Rico would have needed to raise its CHIP income  eligibility standards. When asked what income eligibility rules might be  adopted under statehood, officials from Puerto Rico’s Department of  Health responded that it would be difficult for Puerto Rico to determine  what income eligibility rules would be adopted. Ultimately, we chose to  model three eligibility scenarios.

Assuming Puerto Rico had opted to cover children up to 300 percent  of the FPL.

Assuming Puerto Rico had opted to cover children up to 200 percent  of the FPL.

Assuming Puerto Rico had opted to discontinue its version of CHIP.

To estimate enrollments, we followed a process similar to that for  Medicaid. We assumed that all actual CHIP beneficiaries and individuals  estimated to have received SSI and TANF benefits in 2011 would have  enrolled. As previously described for Medicaid, for all other eligible  individuals, we decided to apply participation rates observed for actual  Puerto Rico Medicaid and CHIP enrollees in the top decile of the  distribution of income-to-poverty ratio by subgroup (i.e., a matrix of age  group, insurance coverage, and disability status), based on the  assumption that newly eligible individuals would be more similar to  higher-income eligible individuals than to lower-income eligible  individuals. The enrollment estimates are by geographic region in  Puerto Rico.

To estimate total (federal and Puerto Rico) CHIP spending, we applied  annualized per member per month rates paid for different categories of  enrolled individuals to estimated enrollments. The annualized per  member per month rates are the same as for Medicaid.

To estimate the federal share of total CHIP spending, we applied a  predicted enhanced federal medical assistance percentage (enhanced  FMAP) to total CHIP spending. The enhanced FMAP is the statutory  formula that determines the federal share of CHIP funding provided to  states and territories. For Puerto Rico, the predicted enhanced FMAP  was 85 percent. We also estimated Puerto Rico’s share of total CHIP  spending to show how it would change under statehood.

section_title: Federal-Aid Highways Estimate
paragraphs: To estimate federal spending on Federal-Aid Highways for fiscal year  2013, we obtained estimates from the Federal Highway Administration  (FHWA) on (1) Puerto Rico highway users’ expected contribution to the  Highway Account of the Highway Trust Fund (the Fund), and (2) Puerto  Rico’s expected apportionment—a division of authorized highway funding  according to statutory formulas. Using these estimates, we determined  Puerto Rico’s net deficit for Federal-Aid Highways.

To estimate Puerto Rico highway user’s expected contribution to the  Fund for fiscal year 2013, FWHA multiplied Puerto Rico’s reported  number of gallons of motor fuel consumed on highways for fiscal year  2011 by the applicable federal tax rate. We confirmed that FHWA  calculated Puerto Rico highway user’s expected contribution to the Fund  with the same process it used for highway users in the states. We did not  independently review FHWA’s process for estimating state users’  contributions into the Fund. However, we reviewed the process in the  past, and FHWA made changes to the process as a result of that  review. Regarding the motor fuel data collected by Puerto Rico, FHWA  officials were unaware of any specific limitations to the data.

To estimate Puerto Rico’s apportionment, FHWA officials ran Puerto Rico  data through a series of formulas on our behalf. Under legislation passed  in July 2012, apportionments for the states in fiscal year 2013 are virtually  the same as apportionments for fiscal year 2012, which, in turn, were  based on apportionments for fiscal years 2009 and 2011.apportionment for fiscal year 2009 was calculated using a series of 13  statutory formulas linked to sub-programs. The formulas rely on data  elements—referred to as factors—such as total lane miles eligible for  Federal-Aid Highways, and vehicle miles traveled on open Interstates.

Some factors were unavailable for Puerto Rico and were entered as zero  in the calculations. According to FHWA officials, the unavailable data  had no effect on the estimated apportionment because of Equity Bonus  computations. The Equity Bonus, in effect for fiscal year 2009,  guaranteed that each state received at least a share of combined  apportionments and High Priority Projects equal to 92 percent of  contributions from highway users from that state to the Highway Account  of the Fund. Similarly, as stated in prior work, the underlying data and  factors are ultimately not meaningful for determining apportionments  because they are overridden by other provisions that yield a  predetermined outcome—in particular, the Equity Bonus under prior  legislation. The estimated Puerto Rico apportionment for fiscal year  2009 was adjusted to meet the 92 percent Equity Bonus minimum relative  rate of return.

Given the overriding effect of Equity Bonus on the estimated Puerto Rico  fiscal year 2009 apportionment—and, consequently, the fiscal year 2013  estimated apportionment—we did not verify the reliability of the Puerto  Rico data that fed into the apportionment calculations. Additionally, we did  not verify that the formulas FHWA used were consistent with the relevant  statutes. However, we confirmed that FHWA used the same formulas and  process for calculating state apportionments as were used for fiscal year  2009, which, by law, is the basis for fiscal year 2013 apportionments.

section_title: Potential Changes to Selected Sources of Federal Revenue
paragraphs: To evaluate potential changes to selected sources of federal revenue  under Puerto Rico statehood, we reviewed federal laws and regulations  related to the main sources of federal revenue in 2012—individual income  tax (which accounted for 46.2 percent of federal revenue in 2012),  employment tax (34.5 percent), corporate income tax (9.9 percent),  excise tax (3.2 percent), customs duties (1.2 percent), and estate and gift  taxes (0.6 percent). We also estimated potential changes in revenue for  individual and corporate income taxes—the two largest revenue sources  that would be affected substantially by statehood. As with our estimates  of potential changes in federal spending, our estimates of potential  changes in federal revenue involve uncertainty. To some extent, the  various scenarios for estimates revenue capture how these assumptions  would impact revenue. However, there may be sources of uncertainty and  dynamic changes in economic activity that would affect revenue that we  could not incorporate into our modeling.
subsections: section_title: Individual Income Tax
paragraphs: To estimate potential changes to individual income tax, we obtained data  for all individuals who filed a Puerto Rico individual income tax return for  tax year 2010, the most recent complete year of tax return data available  when we began our work. We obtained these data from Puerto Rico’s  Department of Internal Revenue. The 2010 Puerto Rico individual income  tax return generally includes information comparable to the federal  individual income tax return. However, it does not include some items that  are included on the federal return, and Puerto Rico law defines certain  items differently. According to Puerto Rico officials, variations between the  two returns include the following:

Puerto Rico does not tax income from Social Security benefits or  unemployment compensation. Thus, these items are not included on  the Puerto Rico return. Under statehood, these forms of income would  be subject to federal income tax. Because we excluded these items,  our estimates of aggregate individual income tax revenue under  statehood could be understated.

Winnings from the Lottery of Puerto Rico and racetracks are exempt  from Puerto Rico income tax. Under statehood, this income would be  subject to federal income tax. Excluding these items could have  resulted in understated estimates.

Some federal income tax deductions—such as for taxpayers and their  spouses who are blind—and some tax credits (such as for qualified  expenses paid to adopt an eligible child) have no equivalent under  Puerto Rico income tax law and therefore are not reported on Puerto  Rico returns. Excluding these items could have result in overstated  estimates.

Puerto Rico defines short-term capital gains as those from the sale or  exchange of capital assets held for 6 months or less. In comparison,  federal tax law defines short-term capital gains as those from capital  assets held for one year or less. Under the federal income tax, short- term gains are taxed as ordinary income, at rates that may be higher  than those at which long-term gains are taxed for some taxpayers.  Because we used capital gain information as reported on the Puerto  Rico returns, our estimates may be understated.

The Puerto Rico tax return does not distinguish between qualified and  ordinary dividends. Qualified dividends generally are subject to a  lower federal income tax rate than are ordinary dividends. For our  estimate, we assumed that Puerto Rico qualified dividends would  have comprised the same percentage of total dividends (74 percent)  as for dividends reported on federal income tax returns in 2010.

The federal tax system generally allows taxpayers to carry back and  carry forward net operating losses for 2 and 20 years, respectively; in  contrast, Puerto Rico only allows net operating losses to be carried  forward for 10 years. Consequently Puerto Rico filers might have  been able to reduce their federal tax liabilities to a greater extent than  observed on the Puerto Rico tax returns we used.

We used the National Bureau of Economic Research’s TAXSIM  program—which models U.S. federal and state income tax systems—to  estimate the aggregate federal income tax liability for 2010, as if each  Puerto Rico individual income tax filer had filed a U.S. individual tax  return per U.S. tax law as of January 2, 2013.payments in excess of tax liability for the three largest refundable tax  credits: the American Opportunity Tax Credit (AOTC), child tax credit   We also estimated  (CTC), and earned income tax credit (EITC).accounted for 94 percent of obligations from refundable credits in fiscal  year 2012.

In addition to the variations between Puerto Rico and federal tax returns  as described above, the estimates are based on the following  assumptions:

Puerto Rico filers would not have changed their behavior related to  work, investment, or income reporting as a result of the imposition of  federal tax requirements.

All filers who would have been eligible for the refundable credits would  have claimed them.

Puerto Rico residents’ compliance with tax laws would have remained  constant under statehood.

Different assumptions would have resulted in different estimates. For  example, some Puerto Rico residents who decided not to file a Puerto  Rico return might have filed a federal return in order to receive payment  from one or more of the refundable tax credits, had they been eligible. In  addition, the Joint Committee on Taxation has noted that taxpayer  compliance would likely increase under statehood because the federal  Internal Revenue Service (IRS) has relatively more resources to enforce  tax laws than does Puerto Rico’s Department of Internal Revenue.  Under statehood, Puerto Rico filers may report their income at higher  levels of compliance as a result.

We also developed an assumption to account for the possibility that  Puerto Rico could change its own local income tax rates under statehood.

Puerto Rico’s local income tax rates would be relatively high compared to  those of the states. For example, the highest marginal tax rate in Puerto  Rico for 2010 was 33 percent. In comparison, the 2010 highest marginal  tax rate in the states was 11 percent (Hawaii and Oregon). How Puerto  Rico’s government would respond to the imposition of federal income  taxes is unknown. However, one possibility is that it would reduce its  income tax rates to be more in line with those from other states. Puerto  Rico’s equivalent of a state income tax rate is relevant to estimates of  aggregate tax liability and refundable credit payments because some  filers would be able to deduct state and local taxes paid on their federal  returns. Accordingly, we developed an alternate scenario for estimating  aggregate tax liability and refundable credit payments based on Puerto  Rico reducing its income tax rates. Under this alternative scenario, we  imputed amounts for the deduction for state and local taxes paid (using  reported data from IRS’s Statistics of Income program for 2010) based on  the national average deduction as a percentage of adjusted gross income  (3.3 percent).

To determine the amount of federal income tax that Puerto Rico residents  actually paid for 2010, we used data reported on Puerto Rico tax returns.  We used these data because, although IRS publishes data on taxes  collected by state (and for Puerto Rico) the amounts for individual and  employment taxes are combined. According to IRS officials, the agency  cannot separate the amounts for these two types of taxes at the state  level. Instead, we used information reported on the Puerto Rico tax  returns as a proxy for the amount of federal income tax paid. Puerto Rico  allows a credit for taxes paid to the United States, its possessions, and  foreign countries. According to officials from Puerto Rico’s Department of  Internal Revenue, most of these taxes would have been paid to the  United States. As a result, we used the aggregate tax amount that  taxpayers reported in calculating the credit as the upper bound of federal  income tax that would have been paid for 2010.

section_title: Corporate Income Tax
paragraphs: To estimate potential changes to corporate income tax revenue, we  obtained data on net operating income or losses, losses carried forward  from prior years, and credits for taxes paid to the United States for every  entity that filed a business income tax return for tax year 2009, the most  recent complete year of tax return data available when we began our  work. We obtained these data from Puerto Rico’s Department of Internal  Revenue. We focused on these items because they are the best available  proxies for the income and losses that would be taxed under the federal  corporate income tax if Puerto Rico were to become a state. Net  operating income or losses reported on Puerto Rico tax returns are  computed in a manner broadly similar to how they are computed on  federal returns (although the manner in which that income is taxed, if at  all, can differ).

We divided the Puerto Rico business entities into three categories based  on the type of tax returns they filed.

Regular corporations, which filed the standard corporate income tax  return.

Regular partnerships, which (in 2009) were subject to an entity-level  income tax and filed returns largely identical to the regular corporate  income tax return.

Exempt businesses, which had been granted partial or full exemptions  of their business income under one of Puerto Rico’s tax incentive  laws, and filed special tax returns.

Within the Puerto Rico tax return data, we could not always determine  whether the filing entities were (1) branches of other corporations, (2)  subsidiaries of other corporations, or (3) separate Puerto Rico entities.  Likewise, officials from Puerto Rico’s Department of Internal Revenue told  us that the data would not provide sufficient or reliable information on the  country of incorporation for any of the filing businesses or for their parent  corporations. Consequently, we made a range of assumptions regarding  the percentage of the filing entities’ income attributable to either (1)  branches or subsidiaries that would have been included in the  consolidated federal corporate income tax return of a U.S. corporation, or  (2) corporations that would have been taxed as separate entities under  statehood. These distinctions mattered in terms of which tax rates we  applied when making our estimates and how we treated accumulated  losses.

In addition, we did not have data for the amount of state and local income  taxes that the filing entities would have paid in Puerto Rico if it had been a  state. As a result, we needed to estimate these amounts, because they  represent an important deduction under the federal corporate income tax.  As with the individual income tax, Puerto Rico’s corporate income tax  rates are relatively high compared to those in the states. For example,  Puerto Rico’s highest marginal tax rate in 2010 for regular corporations  was 19 percent; the highest corporate tax rate in the states in 2010 was  12 percent (Iowa). How Puerto Rico’s government would respond to the  imposition of federal corporate income tax is unknown; however, if Puerto  Rico were placed in the same fiscal relationship to the federal  government as the 50 states, it might reduce its rates to be more in line  with those from other states. Consequently, we assumed that under  statehood, the effective rate of Puerto Rico’s income tax would be similar  to the average effective rate for income taxes levied in the states (the rate  for profitable corporations was 3.8 percent of net income; for corporations  with losses it was -1.0 percent).estimate this average rate for the states.

We used data compiled by IRS to  We also needed to make assumptions regarding which federal tax rates  would have applied to these entities’ net income under statehood. In the  case of corporations taxed as separate entities, we assumed an effective  tax rate falling within a broad range (from 15 percent to 35 percent)  around the average effective tax rate that U.S. corporations paid for tax  year 2009. We used this range to reflect the possibility that the tax  attributes of the typical corporation operating in Puerto Rico could have  differed from those of the typical U.S. corporation.

On the advice of tax experts from the Joint Committee on Taxation, we  used a different approach to determine tax rates for entities included in  the consolidated returns of controlled groups of U.S. corporations. For  these corporations, the applicable rate of tax depended not only on the  Puerto Rico entities’ net income, but also on the income and losses of  other group members, and on the credits earned by the group as a whole.  For these entities, we applied the marginal federal tax rate for the  consolidated group to the net income (or losses) that the Puerto Rico  entity would have added to the group’s tax return. For entities in the  financial services and social services industries, we applied the full 35  percent corporate marginal tax rate based on the assumption that these  entities would not have qualified for the domestic production activities  deduction. For all other corporations, we reduced the marginal rate to  31.85 percent to reflect the effect of this deduction.

We estimated tax liabilities both before and after applying prior-year  losses to offset income from 2009. We did so because the initial effect  that these prior-year losses would have had on tax revenue may not have  been representative of their effects over a longer time period. In the first  year of statehood, when Puerto Rico subsidiaries of U.S. corporations  first become subject to federal tax and are consolidated into their parent  corporations’ tax returns, large portions of their losses could be used to  offset the taxable income reported on those returns, leaving only smaller  amounts (or newly generated losses) available to offset income in  subsequent years.

We also made assumptions to account for the potential relocation, under  statehood, of businesses with activities in Puerto Rico. Tax experts at the  U.S. Department of the Treasury and the Joint Committee on Taxation  suggested that the changes in tax treatment that would occur under  statehood likely would motivate some businesses to move their  operations from Puerto Rico to lower-tax foreign locations—particularly  those with substantial amounts of income derived from intangible (and  therefore mobile) assets. For 2009, exempt corporations in the  pharmaceutical and the medical equipment and supplies industries  accounted for over 70 percent of the net income (and about 20 percent of  accumulated losses) of the full population of exempt corporations. In  addition, other industries with potential income from intangible assets  accounted for significant shares of total net income.

Using the other assumptions described above, we produced an  alternative set of estimates to account for the potential relocation, under  statehood, of businesses with activities in Puerto Rico. The first set of  estimates assumes that all filing businesses would have maintained their  activities in Puerto Rico. The second set of estimates assumes that (1) all  filing businesses in the pharmaceuticals and the medical equipment and  supplies industries would have relocated away from Puerto Rico, and (2)  other filing business would have maintained their activities in Puerto Rico.

To determine the amount of federal corporate income tax that entities with  activities in Puerto Rico actually paid in 2009, we used data that U.S.  corporations reported to IRS on Form 1118 on income they received in  2009 from their Puerto Rico branches or subsidiaries. To estimate the  amount of tax that would have been paid, we applied a tax rate of 31.85  percent (the 35 percent corporate tax rate reduced to account for the  domestic production activities deduction) to the remaining income.

Separately, published IRS data show that the agency collected about  $145 million (net of refunds) in business income taxes from entities in  Puerto Rico in fiscal year 2009. However, this amount included taxes  collected from any tax year, and we could not determine whether any of  the amounts collected overlapped with amounts we estimated based on  Form 1118 (any taxes paid by businesses incorporated in Puerto Rico on  their U.S.-source income would not overlap with those amounts).  Consequently, we did not include any of the $145 million in our estimate  of the amount paid in corporate income tax by entities with activities in  Puerto Rico.

We took several steps to assess the reliability of the Puerto Rico tax  return data we used for our individual and corporate income tax  estimates. For example, to identify possible outliers that could reflect data  errors, we checked maximum and minimum amounts reported for each  tax return line item we used. We also discussed the data with officials  from Puerto Rico’s Department of Internal Revenue, and, in some cases,  adjusted the data to address errors and inconsistencies. Based on our  assessment, we determined that the data were sufficiently reliable for our  purposes. We also discussed our methodology for estimating tax revenue  with tax experts from the Department of the Treasury and the Joint  Committee on Taxation, who generally agreed with our estimation  approaches.

section_title: Factors That Could Affect Federal Spending and Revenue
paragraphs: To identify factors under statehood that could influence changes in  federal spending and revenues, we reviewed economic data from the  Puerto Rico government and reports on the Puerto Rico economy, such  as those from the Federal Reserve Bank of New York and the  Congressional Budget Office. We also interviewed officials from the  current and past Puerto Rico government administrations and Puerto  Rico business associations representing large economic sectors in Puerto  Rico to obtain their views on the potential impacts of statehood on Puerto  Rico’s economy and public finances.

We conducted this performance audit from June 2012 to March 2014 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

section_title: Appendix IV: Potential Effects of the Patient Protection and Affordable Care Act on Federal Spending for Medicare, Medicaid, the State Children’s Health Insurance Program under Puerto Rico Statehood
paragraphs: The Patient Protection and Affordable Care Act (PPACA), enacted in  March 2010, makes substantial changes to Medicare and Medicaid, as  well as other components of the federal budget. There are significant  uncertainties surrounding the effects of PPACA on health care spending  and on other factors that influence future health care costs more  generally—such as how the development and deployment of medical  technology, future policy decisions, and cost and availability of insurance  affect growth in per-capita health care spending. These factors could  influence our estimates of federal spending for Medicare, Medicaid, and  the State Children’s Health Insurance Program (CHIP) under Puerto Rico  statehood. Below we summarize selected PPACA provisions that may  affect federal Medicare, Medicaid, and CHIP spending in Puerto Rico.
subsections: section_title: Medicare
paragraphs: PPACA is projected to decrease direct Medicare spending by almost  $400 billion from fiscal years 2010 to 2019, according to the  Congressional Budget Office (CBO). The following table summarizes  selected PPACA provisions that have affected, or could potentially affect,  federal Medicare spending in Puerto Rico.

section_title: Appendix IV: Potential Effects of the Patient Protection and Affordable Care Act on Federal Spending for Medicare, Medicaid, and the State Children’s Health Insurance Program under Puerto Rico Statehood
paragraphs: The Patient Protection and Affordable Care Act (PPACA), enacted in  March 2010,makes substantial changes to Medicare and Medicaid, as  well as other components of the federal budget. There are significant  uncertainties surrounding the effects of PPACA on health care spending  and on other factors that influence future health care costs more  generally—such as how the development and deployment of medical  technology, future policy decisions, and cost and availability of insurance  affect growth in per-capita health care spending. These factors could  influence our estimates of federal spending for Medicare, Medicaid, and  the State Children’s Health Insurance Program (CHIP) under Puerto Rico  statehood. Below we summarize selected PPACA provisions that may  affect federal Medicare, Medicaid, and CHIP spending in Puerto Rico.
subsections: section_title: Medicare
paragraphs: PPACA is projected to decrease direct Medicare spending by almost  $400 billion from fiscal years 2010 to 2019, according to the  Congressional Budget Office (CBO). The following table summarizes  selected PPACA provisions that have affected, or could potentially affect,  federal Medicare spending in Puerto Rico.

PPACA provisions   (legal citation)  Medicare Advantage (Medicare Part C)  Changes benchmarks underlying payments to Medicare Advantage  (MA) plans to align more closely with Medicare FFS spending. The new  benchmarks will be phased in from 2012 to 2017 and blended with old  benchmarks. In 2017, county benchmarks will be one of four values: 95  percent, 100 percent, 107.5 percent or 115 percent of Medicare FFS  spending. Benchmarks could be increased for certain plans if they are  new, demonstrate indicators of plan quality, or have low enrollment.   PPACA, § 3201 (as amended by HCERA, § 1102) (codified at, 42  U.S.C. § 1395w-23(n)).

Phased-in from  2012 to 2017.

This provision is estimated to reduce  payments to MA plans by about $136  billion from fiscal years 2010 to 2019.  These reductions could result in  reduced benefits and enrollments.   When fully phased in 2017,  benchmarks for Puerto Rico generally  will be 115 percent of Medicare FFS  spending plus any quality bonus  payments. In the long term, the  reduction will result in plans receiving  lower payments. Given the high  enrollment in MA in Puerto Rico, these  changes could significantly affect  Medicare spending.

Medicare prescription drug benefit (Medicare Part D)  Higher premiums will be charged for beneficiaries who exceed certain  income thresholds.  PPACA, § 3308 (codified at 42 U.S.C. § 1395w-113(a)(7)).

January 1, 2011.  This provision is estimated to provide  an additional $10.7 billion in Medicare  funding from fiscal years 2010 to 2019. Although Puerto Rico could benefit  from additional funding, relatively few  Puerto Rico Medicare beneficiaries  may end up paying the higher  premiums given relatively low incomes  in Puerto Rico. This provision would  not be affected by statehood.

PPACA provisions   (legal citation)

Discounts and additional subsidies must be provided to Part D  beneficiaries who purchased covered drugs during the coverage gap, or  “donut hole.” would not benefit from this provision, as they already receive assistance  with costs in the coverage gap. In addition, one-time payments of $250  were provided to certain individuals who incurred costs for covered Part  D drugs exceeding the coverage limit in 2010.  PPACA, §§ 3301, 3315 (as amended by HCERA, § 1101) (codified at,  42 U.S.C. §§ 1395w-152(c), 1395w–153, 1395w–114a).

Potential effects on spending This provision is expected to increase  Medicare spending by $42.6 billion from  fiscal years 2010 to 2019.  As of March 2013, Part D beneficiaries in  Puerto Rico have saved $143 million  under this provision, according to CMS.This provision would not be affected by  statehood.

Unless otherwise noted, projections are from: Congressional Budget Office, H.R. 4872,  Reconciliation Act of 2010-- Final Health Care Legislation, (Washington, D.C.: Mar. 20, 2010).  The donut hole refers to the point when standard Part D plans provide coverage for costs over  $2,970, until out-of-pocket costs reach $4,750 (for 2013), when the plan covers most costs.

section_title: Medicaid and CHIP
paragraphs: CBO estimated that PPACA will increase federal spending on Medicaid   The following  and CHIP by $642 billion over fiscal years 2012 to 2022.table summarizes selected PPACA provisions that have affected, or could  potentially affect, federal Medicaid and CHIP spending in Puerto Rico.

PPACA provisions   (legal citation)

Provides that Medicaid payments to primary care  physicians for services provided in 2013 and 2014 will not  be less than the greater of the Medicare rates in those  years or the payments rates that would be applicable in  those years using the 2009 Medicare physician fee  schedule conversion factor. The federal government must  provide a 100 percent match for any increased payments.  The territories, however, are not required to provide these  increased payments to primary care physicians, nor are  they eligible for this enhanced federal match.  HCERA § 1202 (codified at 42 U.S.C. §§ 1396a(a)(13)(C),  1396d(dd), 1396u-2(f)).   Medicaid DSH payments will be reduced under a specified  methodology for 2014 through 2020.  PPACA, §§ 2551, 10201(e)(1)(B) (as amended by HCERA,  § 1203) (codified at 42 U.S.C. § 1396r-4(f)(7)).

Effective date   January 1, 2013.   This provision is expected to increase federal  Medicaid spending by $8.3 billion.  Puerto Rico is not eligible for this enhanced federal  match. Under statehood Puerto Rico would be  required to make these increased payments to  primary care physicians and would receive an  enhanced match for qualified payments, increasing  federal and Puerto Rico Medicaid spending.

October 1, 2013.  This provision is expected to result in $14.1 billion in  savings to the federal government from fiscal years  2014 to 2019. Since Puerto Rico does not qualify for a DSH  allotment as a territory, there is no direct effect from  this provision on actual federal spending in Puerto  Rico. Under statehood, Puerto Rico would become  eligible for a DSH allotment; however, according to  CMS officials, the methodology for calculating that  allotment is unclear because a state’s allotment is  based on its prior year allotment.

Beginning October 1, 2015, the enhanced FMAP for CHIP  will increase by 23 percentage points, not to exceed 100  percent, which will continue until September 30, 2019.   PPACA, §§ 2101(a), 10203(c)(1) (codified at 42 U.S.C.  § 1397ee(b)).

October 1, 2015.   Under statehood, the increased enhanced FMAP  may impact the level of CHIP coverage that Puerto  Rico would select.

Unless otherwise noted, projections are from Congressional Budget Office, H.R. 4872, Reconciliation  Act of 2010 (Final Health Care Legislation) (Washington, D.C.: Mar. 20, 2010).

The Bipartisan Budget Act of 2013 amended the reduction of Medicaid DSH payments. Specifically,  it delayed the reductions for two years until October 1, 2015 and doubled the reduction that otherwise  would have applied in that year. Additionally, it added another special rule for calculating Medicaid  DSH allotments in 2023. Pub. L. No. 113-67, § 1204, 127 Stat. 1165, 1199.

section_title: Appendix V: Comments from the Governor of Puerto Rico

section_title: Appendix VII: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact

section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, key contributors to this report  were Jeff Arkin, Assistant Director; Susan T. Anthony; Benjamin Bolitzer;  Gerardine Brennan; Christine Brudevold; Virginia (Jenny) Chanley; Steve  Cohen; James C. Cosgrove; Kevin Daly; Bertha Dong; Deirdre Duffy;  Elizabeth Fan; Ellen Grady; Shirley Jones; Michael Kendix; Kathleen M.  King; Laurie King; Hayley Landes; Kathryn Larin; Dan Meyer; Donna  Miller; John Mingus; Meredith Trauner Moles; Ruben Montes de Oca;  Edward Nannenhorn; Jeffrey Niblack; Keith O’Brien; Rhiannon Patterson;  Amy Radovich; Robert Robinson; Erin Saunders Rath; Cherié Starck;  Andrew J. Stephens; Lindsay Swenson; Hemi Tewarson; Daniel Webb;  Monique B. Williams; James Wozny; Robert Yetvin; and Carolyn L.  Yocom.


Question-summary annotations: questions: question: How would Puerto Rico statehood affect the federal programs GAO reviewed?
answer: Of the 29 federal programs GAO reviewed (which accounted for about 86 percent of federal program spending for states or their residents in fiscal year 2010), statehood would likely affect 11 programs.
child_questions: question: How could Puerto Rico statehood affect eligibility determinations for certain programs?
answer: For 3 other programs, while the programs themselves would likely not change under statehood, eligibility determinations for these programs could be affected indirectly by changes that could occur to benefits in other programs.

question: To what extent would Puerto Rico statehood affect the remaining programs?
answer: Statehood would not likely affect the 15 remaining programs.

questions: question: What assumptions underly the projected change in federal spending that Puerto Rico statehood would prompt?
answer: The extent to which federal spending would change for some of the programs affected by Puerto Rico statehood depends on various assumptions: these assumptions include the program eligibility options Puerto Rico might select or the rates at which eligible residents might participate in the programs.
child_questions: question: How did GAO estimate the chance for large federal programs?
answer: For example, for the four largest programs for which federal spending likely would change under statehood—Medicare, Medicaid, the Supplemental Nutrition Assistance Program (SNAP), and Supplemental Security Income (SSI)—GAO used various assumptions to estimate the range of potential effects on federal program spending.

question: How were the estimated ranges for the four programs created?
answer: The estimated ranges for the four programs, as described below, are based on Puerto Rico being treated the same as the states in either 2010 or 2011, based on the year for which GAO had the most recent data.

questions: question: What revenue could be affected by Puerto Rico becoming a state?
answer: All the federal revenue sources GAO reviewed—individual and corporate income taxes, employment tax, excise tax, estate and gift taxes, and customs duties—could be affected if Puerto Rico became a state.
child_questions: question: How would federal income tax revenue change?
answer: For example, under statehood, Puerto Rico residents would be subject to federal tax on all their income: currently, they are subject to federal tax only on income from sources outside of Puerto Rico.

question: Why would other sources of revenue change?
answer: Also, some sources of income, such as pension income, are taxed differently in Puerto Rico than in the states. As a result, for 2010, Puerto Rico filers' adjusted gross income for federal tax purposes would have been higher than that for Puerto Rico tax purposes.

question: What factors make these changes hard to predict?
answer: For some revenue sources, the extent to which federal revenue would change depends on various assumptions. For example, for the two largest revenue sources that would be affected substantially by statehood—individual and corporate income taxes—GAO used various assumptions to estimate a range of federal revenue.

question: What are the estimate ranges based on?
answer: The estimate ranges, as described below, are based on Puerto Rico being treated the same as the states in either 2009 or 2010, based on the year for which GAO had the most recent data.

questions: question: What other factors would affect changes in federal revenue if Puerto Rico became a state?
answer: Puerto Rico faces various economic and fiscal challenges that could potentially impact changes in federal spending and revenue under statehood.
child_questions: question: How is the health of Puerto Rico's economy?
answer: For example, its economy largely has been in recession since 2006, and its levels of employment and labor force participation are relatively low, compared to those of the states.

question: What is the status of Puerto Rico's public debt?
answer: Persistent deficits have resulted in an increase in Puerto Rico's public debt, which represents a much larger share of personal income than in any state (and in February 2014, Puerto Rico's general obligation bonds were downgraded to speculative—noninvestment—grade by three ratings agencies).

question: In what ways has Puerto Rico taken to improve its fiscal position?
answer: Puerto Rico has taken recent steps to improve its fiscal position, such as reducing its government workforce and reforming its largest public employee retirement system.
child_questions: question: What factors could further prompt such changes?
answer: Changes in federal program spending and to federal tax law under statehood could lead to economic and fiscal changes of their own in Puerto Rico. That may have a cascading effect on federal spending and revenue levels. However, the precise nature of such changes is uncertain.
child_questions: question: What are the policy implications of such possible changes?
answer: Because statehood would cause numerous adjustments important to Puerto Rico's future, it would require careful consideration by Congress and the residents of Puerto Rico. Consequently, statehood's aggregate fiscal impact would be influenced greatly by the terms of admission, strategies to promote economic development, and decisions regarding Puerto Rico's government revenue structure.

questions: question: What was GAO asked to review?
answer: GAO was asked to review potential fiscal implications for federal programs if Puerto Rico were to become a state.

question: What does the report examine?
answer: This report examines potential changes to selected federal programs and related spending changes, and changes to selected federal revenue sources that would be expected should Puerto Rico become a state.
child_questions: question: What factors under statehood does the report discuss?
answer: This report also discusses economic and fiscal factors under statehood that could influence changes in spending and revenues.