In the wake of the coronavirus outbreak, public health officials and policy experts have raised concerns that the U.S. is too dependent on China for critical active pharmaceutical ingredients—the compounds essential to manufacturing common medicines like penicillin, Advil, and Tylenol. The good news is that there are ways for Congress to jump-start American pharmaceutical ingredient manufacturing, by reforming the tax code of Puerto Rico.
Why Puerto Rican drug manufacturers moved to China
Until relatively recently, Puerto Rico was a dominant player in the manufacture of prescription drugs. The reason? Taxes.
In Gerald Ford’s last year as President, the Democratic Congress passed—and Ford signed—the Tax Reform Act of 1976, which exempted from taxation corporate income generated in U.S. territories, like Puerto Rico, Guam, and the U.S. Virgin Islands. This policy, combined with Puerto Rican tax law, meant that corporate subsidiaries based in Puerto Rico enjoyed a zero percent corporate tax rate, so long as they distributed their profits as dividends.
Pharmaceutical companies were well suited to take advantage of this tax break—contained in Section 936 of the Internal Revenue Code—for drug manufacturing. Companies could base their manufacturing operations in Puerto Rico, and thereby significantly reduce their U.S. tax burden. A 1993 report from the U.S. Government Accountability Office estimated that pharmaceutical companies represented, by far, the largest beneficiaries of the Puerto Rican corporate tax system, benefiting to the tune of $86 million in 1985.
Over time, Congress whittled away at the Puerto Rican tax break. Finally, in 1996, President Bill Clinton signed into law the Small Business Job Protection Act of 1996, which phased out Section 936, fully repealing the tax break in 2006. The measure was hailed at the time as “ending corporate welfare as we know it.”