Puerto Rico as a Tax Haven or a U.S. State: An Analysis of Two Outcomes And the Impacts They May Have on the Island

Abstract

The purpose of this paper is to evaluate two policy outcomes as means for improving the economic conditions in Puerto Rico. One, which is currently in use by Puerto Rico’s government, is offering tax incentives to individuals and businesses that locate on the island through the Act to Promote the Exportation of Services as well as the Act to Promote the Transfer of Investors to Puerto Rico, which are respectively known as Act 20 and Act 22. The benefits provided by these Acts would effectively allow Puerto Rico to make itself a tax haven for the various businesses and individuals that make use of them. An alternative strategy would be for Puerto Rico to change the nature of its relationship with the United States: leaving behind the island’s current political status as a territory of the United States and instead becoming a fullfledged state of the United States. As becoming a state is bound to change the nature of federal taxation regarding Puerto Rico, the tax incentives currently offered would no longer be as effective in that outcome. This entails that being a state and being a tax haven are incompatible for Puerto Rico. This paper uses the Solow model to examine potential effects that Acts 20 and 22 and statehood could potentially have on the island. It reaches the conclusion that both being a tax haven and a state can ultimately benefit the island on the basis of this model, however, statehood is ultimately the superior option. This is because Puerto Rico as a state would improve Puerto Rico’s position in and protection under the federal legislative process, and further provide additional benefits to the island.