To provide a basis for future decisions regarding legislation on Puerto  Rican economic issues, this report  explains how the U.S. federal tax treatment of individuals and  businesses in Puerto Rico and of the insular government differs relative  to the treatment of governments, businesses, and individuals in the  states and the other U.S. insular areas;  compares trends in Puerto Rico’s principal economic indicators since  the early 1980s with similar indicators at the national level for the  United States and provides what is known about capital flows between  Puerto Rico and the United States and between Puerto Rico and foreign  countries;  reports on changes in the activities and tax status of the corporations  that have claimed the possessions tax credit since 1993;  provides information on the distribution of private-sector economic  activity in Puerto Rico by type of business entity;  describes the total amount of tax paid by individuals and businesses in  the states and the U.S. insular areas and shows percentage breakdowns  by type of tax; and  describes how the principal U.S. federal social programs apply to Puerto  Rican residents, relative to residents of the states and the other U.S.  insular areas. Puerto Rican residents are  required to pay local income taxes on income earned from Puerto Rican  sources, but not federal income taxes. Its work will  evaluate legislative options concerning Puerto Rico. Scope and Methodology

The Chairman and Ranking Minority Member of the U.S. Senate Committee  on Finance asked us to study fiscal relations between the federal  government and Puerto Rico and trends in the Commonwealth’s economy  with a particular focus on the activities of possessions corporations  operating there. These limitations are noted in the report. In 1996, the possessions tax credit was fully repealed for taxable years  beginning after 2005. GNP differs from GDP by this  amount. Those  data indicate that much of the decline in activity of possessions  corporations in the manufacturing sector was offset by the growth in other  corporations, so that some measures of aggregate activity remained close  to their 1997 levels. For example, value added in manufacturing remained  fairly constant between 1997 and 2002. The Pharmaceutical Industry Has Dominated the Use of the Possessions Tax Credit in Puerto Rico

Most of the possessions tax credit and income earned by possessions  corporations in Puerto Rico has been earned by corporations in the  pharmaceutical industry. A little less than two-thirds of the CFCs’ value added and half of their  employment is attributable to CFCs incorporated outside of Puerto Rico. Taxes Per Capita in Puerto Rico Are Lower Than in the States but Are about the Same Share of Income

The taxes paid to all levels of government (federal, Commonwealth, and  local) in Puerto Rico in 2002 were $3,071 per capita—considerably less  than the per capita taxes of $9,426 paid in the states. Puerto Rico’s outstanding government debt in 2002 was much higher  than that of state and local governments as a share of personal income,  partly because the Commonwealth government has a wider range of  responsibilities.
Why GAO Did This Study

The federal possessions tax credit, which was designed to encourage U.S. corporate investment in Puerto Rico and other insular areas, expires this year. Proponents of continued federal economic assistance to Puerto Rico have presented a variety of proposals for congressional consideration. In response to a request from the U.S. Senate Committee on Finance, this study compares trends in Puerto Rico's principal economic indicators with those for the United States; reports on changes in the activities and tax status of the corporations that have claimed the possessions tax credit; explains how fiscal relations between the federal government and Puerto Rico differs from the federal government's relations with the states and other insular areas; and compares the taxes paid to all levels of government by residents of Puerto Rico, the states, and other insular areas. GAO used the latest data available from multiple federal and Puerto Rican government agencies. Data limitations are noted where relevant. Key findings are based on multiple measures from different sources. GAO is not making any recommendations in this report. In comments on this report the Governor of Puerto Rico said the report will be useful for evaluating policy options.

What GAO Found

Puerto Rico's per capita gross domestic product (GDP, a broad measure of income earned within the Commonwealth) in 2005 was a little over half of that for the United States. Puerto Rico's per capita gross national product (GNP, which covers income earned only by residents of the Commonwealth) was even lower relative to the United States. Concerns about Puerto Rico's official price indexes make it difficult to say whether the per capita GNP of Puerto Rican residents has grown more rapidly than that of U.S. residents; however, the absolute gap between the two has increased. U.S. corporations claiming the possessions tax credit dominated Puerto Rico's manufacturing sector into the late 1990s. After the tax credit was repealed in 1996 beginning a 10-year phaseout period, the activity of these corporations decreased significantly. Between 1997 and 2002 (the latest data available) valued added in these corporations decreased by about two-thirds. A variety of data indicates that much of this decline was offset by growth in other corporations, so that some measures of aggregate activity remained close to their 1997 levels. For example, value added in manufacturing remained fairly constant between 1997 and 2002. Most of the offsetting growth was in the pharmaceutical industry. Residents of Puerto Rico pay considerably less total tax per capita than U.S. residents. However, because of lower incomes they pay about the same percentage of their personal income in taxes. The composition of taxes differed between Puerto Rico and the states with federal taxes being a larger share of the total in the states. This difference reflects the facts that (1) residents of Puerto Rico generally do not pay federal income tax on income they earn in the Commonwealth and (2) the Commonwealth government has a wider range of responsibilities than do U.S. state and local governments.