Yet, characteristics of federal  programs in Puerto Rico may differ from the states for other reasons. 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. 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. 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. Potential Changes to Selected Federal Revenue Sources under Puerto Rico Statehood

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. 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. 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 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. Factors under Statehood that Could Influence Changes in Federal Spending and Revenue

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. 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. 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. Effect of a Statehood Transition Period

Under statehood, certain federal programs in Puerto Rico could change  substantially if Puerto Rico were treated the same as the states. 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). Appendix I: Objectives, Scope, and Methodology

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. 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 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). 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. 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. 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. Potential Changes to Selected Sources of Federal Revenue

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 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. 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. 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. 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. Factors That Could Affect Federal Spending and Revenue

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. This provision is estimated to provide  an additional $10.7 billion in Medicare  funding from fiscal years 2010 to 2019. Puerto Rico is not eligible for this enhanced federal  match. 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.
Why GAO Did This Study

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.

What GAO Found

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.

What GAO Recommends

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 .