Wednesday, November 3, 2010

Rum Diaries

. Wednesday, November 3, 2010

Here's an interesting article on how an obscure provision in the U.S. tax code has caused two U.S. territories to go to the mattresses:

Now the spirit once called Kill-Devil has set off a bitter dispute between two United States islands, Puerto Rico and the Virgin Islands, over a tax that the federal treasury collects on rum.

The fight began when the Virgin Islands persuaded the world’s largest distiller, which said it was leaving Puerto Rico, to move to St. Croix by offering a staggering $2.7 billion in tax incentives. The new distillery, for Captain Morgan spiced rum, will provide no more than 70 permanent jobs on the south shore of St. Croix — but it will entitle the Virgin Islands to collect billions in rum tax revenue from Washington.

That bounty comes at the expense of Puerto Rico, where 90 percent of the revenue from the rum tax had been used for public projects and social services rather than corporate incentives. The Virgin Islands has promised to give nearly half its tax revenue back to the distiller, the British company Diageo, prompting a series of charges and countercharges between neighbors roughly 50 miles apart in the Caribbean. ...

The billions of dollars at stake are the result of a quirk in the tax code that was intended to aid the islands while preventing their offshore distilleries from gaining an unfair advantage over competitors in the states.

Because rum producers in the islands are exempt from federal excise taxes, the government imposed an “equalization tax” on Puerto Rican rum producers in 1917 and gave the money to the commonwealth. In 1954, the United States extended the arrangement to the Virgin Islands.


Now the islands are competing to lure producers with tax incentives. Many are complaining that the tax revenue should go to the people, not the corporations, but if the corporations leave there's no revenue for the people at all. So the islands compete against each other, some of the revenue gets redistributed from Puerto Rican citizens to the corporation, and some other revenue gets redistributed from Puerto Rican citizens to Virgin Islands citizens. Bad for Puerto Ricans, but great for Virgin Islanders.

Of course, absent the equalization tax the corporation would have moved out of the U.S. jurisdiction entirely, likely to Guatemala or Honduras, and both U.S. territories would lose. In any case, tax incentives matter, and they can be very distorting.

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