representatives of the Commonwealth of Puerto Rico appeared before your committee, the committee concluded that:

It is inappropriate to disturb the existing relationship between the possession investment incentives and the United States tax laws because of the important role it is believed they play in keeping investment in the possessions competitive with investment in neighboring countries.

The committee explained that:

The United States Government imposes upon the possessions various requirements, such as minimum wage requirements and requirements to use United States flagships in transporting goods between the United States and various possessions, which substantially increase the labor, transportation and other costs of establishing business operations in Puerto Rico. Thus, without significant local tax incentives that are not nullified by United States taxes, the "possessions would find it quite difficult to attract investments by United States corporations." (H. Rept. 93-1502-93d Cong., 2d sess. on H.R. 17488 (1974) pp. 168–173.)

However, the committee made certain changes designed to enhance the economy of Puerto Rico while at the same time eliminating the existing tax exemption for income from investments outside of Puerto Rico.

The committee decided that U.S. corporations operating in Puerto Rico are to be taxed on the worldwide income but to have the full credit for U.S. taxes for business and qualified investment income from Puerto Rico whether or not tax is paid to Puerto Rico. This recommendation was incorporated in a new section 936 of the Internal Revenue Code.

Moreover, the committee recognized that it was necessary to retain section 332 which exempts from U.S. taxes income derived from liquidating 931 corporations into the parent companies. In addition. to retaining it, the committee also provided for a deduction to the U.S. parent corporation for dividends received from the 936 corporations so as to permit current repatriation of earnings tax free.

The committee felt that these basic changes would "provide for a more efficient system for exemption of possessions corporations.” Id. st. 170.

For the convenience of the committee, we attach a copy of the pertinent provisions in the committee report.

Favorable provisions in the Federal income tax laws for Puerto Rico are necessary in order to foster industrialization in Puerto Rico which is indispensable to counteract the decline of agriculture and massive unemployment. Puerto Rico has made its contribution to this objective by matching these Federal incentives with incentives of its

own.

This partnership in opportunities has served well the common purposes of the United States and of Puerto Rico. However, the present recession has affected Puerto Rico much more than the United States. It would be disastrous to the Puerto Rican economy if the Federal Government withdrew from this partnership at this time by enacting Federal income tax laws which would discourage investments in Puerto Rico.

Mr. Chairman, I would like Ambassador Moscoso to cover the present economic conditions in Puerto Rico which we believe are very relevant to this situation.

Mr. BURKE. You are recognized, Mr. Moscoso.

Mr. Moscoso. Mr. Chairman and members of the committee, the combined pressures of inflation and recession have been profoundly damaging to the Commonwealth of Puerto Rico to a greater extent than to the U.S. mainland.

There is a series of basic conditions which make the impact of such adverse forces immediate and acute. The total area of Puerto Rico, for the sake of those who do not have the background, is 3,400 square miles, consisting largely of a mountainous spine which limits agricultural development, and we have very few exploitable natural

resources.

The population density is 900 per square mile. This is a larger density than Japan and it compares with about 60 per square mile here in the mainland of the United States.

The overall level of skills of the work forces is still very restrictive. The average unemployment rate during periods of Puerto Rico's most successful growth has far exceeded the present U.S. recession rate of 9 percent. We have been having unemployment rates over the years of between 11 and 12 percent in Puerto Rico consistently.

In spite of this, we still have the highest per capita GNP of any country in Latin America.

Average income levels and maintenance standards in Puerto Rico are far below comparable figures for the United States or any other area in the United States. In terms of per capita income, Puerto Rico's present level is $1,913, about 35 percent of the U.S. average, and less than 60 percent of the average for Mississippi.

The average hourly wage for production workers in Puerto Rico was $2.93 in September 1974 compared to $4.51 for the United States as a whole.

Unemployment in Puerto Rico now at this moment is around 16.2 percent. This is as computed by the traditional statistical method but this figure really understates the real problem. Individuals have given up searching for jobs and therefore do not appear any longer in the official statistics as being unemployed.

A more realistic unofficial estimated unemployment would put the figure around 30 percent. An alarming factor for indicating acceleration of the problem is a sharp drop in the size of the labor force in recent months.

Furthermore, industrial employment in Puerto Rico for April 1975, just a couple of months ago, was some 21,300 below the average for the fiscal year ending June 30, 1974, a decrease of 14 percent in the industrial workers.

Employment in factories under my agency's development program suffered a net loss of 11,000 jobs during the first 9 months of the fiscal year. As a matter of fact, this year we ended the promotional year, fiscal year, with 17,000 new industrial jobs created versus 23,000 jobs created the year before. But if you deduct from those new jobs the number of jobs that have been lost, we are going to wind up the year with a net loss of industrial employment.

Seventy-five percent of all the goods consumed in Puerto Rico have to come from overseas and about 80 percent of these imports are from the U.S. mainland. Indeed, Puerto Rico is the fifth largest export market for U.S.goods.

In fiscal year 1974, the prices of imported goods in Puerto Rico increased by some 36 percent with the burden of course falling on the consumer. This was seriously felt through increases in prices of foodstuffs and petroleum products.

The significance of this sharp change can be appreciated when it is considered that the 1970 census reported 60 percent of the Puerto Rican families were below the U.S. poverty threshold while in the United States the average was only 10 percent.

The problems of Puerto Rico have been particularly aggravated by the role of imported petroleum in the production of energy. Puerto Rico, gentlemen, is completely dependent on imported petroleum, not only for the production of energy, but also for its industrial materials for feedstocks. This petroleum comes principally from Venezuela. We have miniscule quantities of hydroelectric power. We have no coal, no natural gas, and no nuclear power.

In the mainland United States, even though the present extent of dependence on foreign oil is viewed with alarm, the fact remains that 80 percent of the total energy requirements is derived from domestic sources. In the case of Puerto Rico, it is 100 percent from foreign

sources.

In 1974, the cost of a barrel of petroleum in Puerto Rico rose to over four times the cost prevailing in 1973. The increase involved a net withdrawal of around $450 million from the economy of Puerto Rico. This burden cut sharply and suddenly into our living standards and caused a chain of disruptions in the process of economic production. The impact of the energy problem, inflation and the still worsening recession has had a serious adverse impact on the financial and fiscal conditions of the Commonwealth Government. There has been a sharp and immediate setback in revenue collections. Consumers have reduced their expenditures for certain purchases such as automobiles, electric appliances, alcoholic beverages, all subject to excise taxes, and increased costs have reduced profit margins in many businesses, thereby resulting in lower corporation payments.

At the same time, government expenditures have been expanding to meet the rising costs imposed by inflation and rising prices. As a result, Puerto Rico was faced with a $200 million budget deficit last years and is faced with a $300 million deficit this year, which has been cured only through the most drastic fiscal measures.

The Commonwealth has had to resort to alternatives, enormous tax increases, reductions of expenses through postponement of tax obligations and salary increases for government employees.

Serious dislocations existing in the financial market have made it impossible for Puerto Rico to arrange for all financing, not only for government but various public corporations. This has forced substantial reductions in government programs all along the line, contributing to further deterioration in certain economic sectors, particularly construction.

This series of events has added to the seriousness of the unemployment situation in the Commonwealth.

From past experience, it is known that recouperation of the Puerto Rican economy lags behind that of the mainland United States by 6 to 8 months. While the United States can expect to be on its way to

recovery from the present recession by the end of this year, Puerto Rico still has at least 1 more year to endure the present crisis.

In an economy already functioning below the poverty level on the average, this prospect is discouraging, indeed.

The lessening or elimination of the present longstanding provision of Federal income tax laws which encourage investment in Puerto Rico, without their replacement by the provisions which were recommended by the Ways and Means Committee in the last session of Congress, would stop Puerto Rico's industrial development efforts for all practical purposes.

As previously indicated, Puerto Rico will be unable to attract business investment which its economy needs so desperately.

Mr. BENITEZ. That, Mr. Chairman, concludes our statement. [The statement with attachments follows:]

POSITION OF THE GOVERNMENT OF THE COMMONWEALTH OF PUERTO RICO IN RE FEDERAL INCOME TAX AFFECTING THE COMMONWEALTH OF PUERTO RICO

Mr. Chairman and Members of the Ways and Means Committee, we thank the Committee for affording us the opportunity to discuss with you the provisions in the Internal Revenue Code affecting Puerto Rico. These provisions are the backbone of the industrial development and of the whole economy of Puerto Rico. One of the last acts of the Ways and Means Committee in the last session of Congress was to thoroughly consider these provisions and to make certain recommendations which were incorporated in a new proposed Sec. 936 of the Internal Revenue Code, and related changes in other sections of the Code. We strongly endorse these recommendations and believe they should be quickly enacted into law.

Under Sec. 931 of the Code, a corporation organized under U.S. laws is exempt from Federal income taxes on its income from sources outside the U.S., if it derives at least 80% of its gross income from sources within Puerto Rico in a three-year period, and 50% of its gross income from the active conduct of a trade or business in Puerto Rico for such period. In the last session of Congress, the Ways and Means Committee thoroughly reconsidered the provisions affecting Puerto Rico. After representatives of the Commonwealth of Puerto Rico testified before your Committee, the Committee concluded that "it is inappropriate to disturb the existing relationship between the possession investment incentives and the U.S. tax laws because of the important role it is believed they play in keeping investment in the possessions competitive with investment in neighboring countries. The Committee explained that:

"The U.S. Government imposes upon the possessions various requirements, such as minimum wage requirements and requirements to use U.S. flagships in transporting goods between the United States and various possessions, which substantially increase the labor, transportation and other costs of establishing business operations in Puerto Rico. Thus, without significant local tax incentives that are not nullified by U.S. taxes, the "possessions would find it quite difficult to attract investments by United States corporations".

(H. Rept. 93-1502-93rd Congress, 2nd Session on H.R. 17488 (1974) pp. 168173).

However, the Committee made certain changes designed to enhance the economy of Puerto Rico while at the same time eliminating the existing tax exemption for income from investments outside of Puerto Rico. The Committee decided that U.S. corporations operating in Puerto Rico are to be taxed on the world-wide income but to have the full credit for U.S. taxes for business and qualified investment income from Puerto Rico whether or not tax is paid to Puerto Rico. This recommendation was incorporated in a new section 936 of the Internal Revenue Code. Moreover, the Committee recognized that it was necessary to retain sec. 332 which exempts from U.S. taxes income derived from liquidating 931 corporations. In addition to retaining it, the Committee also provided for a deduction to the U.S. parent corporation for dividends received from the 936 corporation so as to permit current repatriation of earnings tax-free. The Committee felt that these basic changes would "provide for a more efficient system for exemption of

possessions corporations". Id. st. 170. For the convenience of the Committee, we attach a copy of the pertinent porvisions in the Committee Report.

Favorable provisions in the Federal income tax laws for Puerto Rico are necessary in order to foster industrialization in Puerto Rico which is indispensable to counteract the decline of agriculture. Puerto Rico has made its contribution to this objective by matching these Federal incentives with incentives of its own. This partnership in opportunities has served well the common purposes of the U.S. and of Puerto Rico. However, the present recession has affected Puerto Rico much more than the U.S. It would be disasterous to the Puerto Rican economy if the Federal government withdrew from this partnership at this time by enacting Federal income tax laws which would discourage investments in Puerto Rico.

THE ECONOMY OF PUERTO RICO

Puerto Rico is a small, densely populated Island, with few natural resources, located far from major markets and sources of raw materials and capital. The Island is approximately 100 miles long and 35 miles wide with a total area only 3.423 square miles, considerably smaller than the State of Connecticut, Puerto Rico lies some 1,700 miles southeast of New York and 1,000 miles southeast of Miami.

Seventy-two percent of the land has a slope of over 15 degrees and is not suitable for conventional development or mechanized agriculture. Fifty-six percent is mountainous or steeply sloped with a grade of over 35 degrees. Of the total area, 14 percent, mainly in the lowlands, is subject to flooding. Only 24 percent is in cropland, and some of this land should not be farmed.

The population of Puerto Rico as of June 1975 was 3.1 million or 902 per square mile, making it one of the most densely inhabitated areas in the world. Less than two-tenths acre of cropland is available per inhabitant, compared with 1.9 acres in the U.S.

Natural resources consist primarily of the climate, some beaches, limited agricultural land, limestone and low-grade copper deposits, which have only become economic to exploit in recent years. There are geological indications of possible petroleum deposits in very deep offshore waters, but their existence is uncertain as no wells have been drilled in the area.

Although Puerto Rico's industrial development program has brought remarkable progress to the Island, almost half of our people are still poor. On a per capita basis, average personal income was $1,986 in fiscal year 1974, only 40 percent of the U.S. average for the same period: $5,227.

Despite extensive outmigration in the 1950's and 1960's and rapid industrialization, unemployment has hovered between 10 percent and 13 percent for more than two decades. With the prevailing economic crisis it has climbed to 16.7 percent, as of March, 1975.

This situation basically reflects population growth, and loss of employment in traditional industries. Although the Commonwealth government is dealing vigorously with our demographic problem, Puerto Rico's labor force is expected to increase at an annual rate of 28,000 through 1985. Home needlework which provided 51,000 jobs in 1950, albeit poor ones, has disappeared. Agricultural employment has declined from 214,000 in 1950 to 53,000 in 1974, due to rising labor costs, lack of adequate land for mechanization and other factors.

Faced with these circumstances, we have had no other alternative but to emphasize manufacturing, trade, construction, and service industries like tourism. We have invested extensively in the support of agriculture and in new agricultural developments. We have intensified education and job training to strengthen our human potential and have fostered an Islandwide planned parenthood program. Because of our limited natural resources and small internal market, most of our manufacturing has been based on the processing of imported raw materials into products for shipment to the continental U.S. In fiscal year 1974, shipments of manufactured products to the U.S. were $2.8 billion as compared to a gross product in the manufacturing sector of $2.2 billion. Overall, merchandise exports amounted to $3.4 billion. Imports for the same period were $4.2 billion. Thus our total external trade amounted to $7.6 billion or 112 percent of our gross product, a "coefficient of external trade" which is higher by far than that of most industrialized countries, including small ones such as Belgium, Holland, Luxembourg and Switzerland. The corresponding ratio for the U.S. is only 20 percent.

To create this level of economic activity we have had to rely heavily on external investment. During the period 1950-74 cumulative gross investment in productive 56-674-75—3