OCTOBER 1981 - VOLUME 2 - NUMBER 10
U.S. Pharmaceutical Giants Move to Puerto Rico for Tax Breaks
"Driving along the north coast is like taking a stroll through your medicine cabinet…"by A. Lin Neumann
Heading west from San Juan along the north coast of Puerto Rico one encounters a stretch of land that displays the lush beauty of the island. Just past the Rockefeller-owned resort hotels and before the pharmaceutical factories, white sandy beaches spread off to one side and acres of verdant countryside roll of to the other.
In the heart of this idyllic scene off the main highway, Number 2, stands an abandoned sugar plantation. No one quite remembers when it last boiled sugar or who lived in the crumbling plantation house, but there it stands, a kind of monument to the transition which has occurred in the Puerto Rican economy.
Once sugar-based, the island's economy has moved toward an almost complete dependence on U.S. capital and sophisticated technology-particularly in pharmaceuticals. Today, 32 percent of Puerto Rico's gross domestic product derives from pharmaceuticals; in 1967 the figures was 6 percent.
"You can say that Puerto Rico is the pharmaceutical capital of the world," says Jose Sierra, the director of the Pharmaceutical Manufacturers Association of Puerto Rico. Indeed, nearly all the major U.S. and European-based drug concerns operate on the island, which makes driving past the pharmaceutical center on the north coast like taking a stroll through a medicine cabinet filled with familiar brand names such as Merck, Lilly, Abbott, and Upjohn.
A massive corporate tax-break is the basic reason for the boom in pharmaceutical manufacturing in Puerto Rico. The U.S. Federal Tax Reform Act of 1976 made an already lenient tax policy on the island virtually non -existent. ,This law permits U.S. manufacturers to repatriate profits from Puerto Rico whenever they want to, free of U.S. Federal taxes.
Previously, subsidiaries of U.S. corporations in Puerto Rico were subject to the full U.S. corporate income tax-48%--in addition to a 15% Puerto Rican withholding tax. Adding extra benefit to those in the new U.S. act, Puerto Rico reduced its withholding tax in 1976 to 10%.
As a result of the 1976 tax reform, U.S. pharmaceutical companies also enjoy a tax holiday on Puerto Rican corporate income and property taxes, of 90% for the first five years of operation and 75% subsequently. Under this law, U.S. companies also receive 100% exemption from municipal taxes in Puerto Rico, and pharmaceutical companies qualify for a special 5% payroll deduction.
To complement the tax break, Puerto Rico has a natural limestone aquifer on its north coast that the pharmaceutical industry finds attractive, since the aquifer provides a clean, efficient source of water, necessary for chemical production. The presence of natural sinkholes and other drainage facilities also provides the firms with a convenient outlet for waste products.
Pharmaceutical companies have taken full advantage of Puerto Rico's incentives. Schering-Plough, for example, in 1977 recorded 67% of its worldwide earnings in Puerto Rico; Abbott 71 %; Lilly and Merck each recorded more than 20%.
The 57 pharmaceutical companies operating in Puerto Rico in 1978 reported revenues of $2.2 billion, costs of $662 million, deductions of $505 million, and profits of slightly more than $1 billion.
For all the benefits Puerto Rico provides the pharmaceutical companies, the country gains little in return. "There is simply no multiplier effect," says Elias Gutierrez, professor of economics at the University of Puerto Rico. Pharmaceutical companies are not dynamically linked into the Puerto Rican economy; "they buy labor, utilize the infrastructure and make use of government subsidies. That's it," Gutierrez says.
Moreover, the pharmaceutical industry does not go far in ameliorating Puerto Rico's employment problems. Out of roughly 154,000 persons employed in the manufacturing sector in Puerto Rico, only 11,000 or 7% of the industrial workforce is employed in the pharmaceutical industry, although it accounts for 32% of the country's gross domestic product.
While adding little to the economy, the pharmaceutical companies may actually be ruining the environment of the island. One alarming sign: the water level in the acquifer is beginning to drop. "When the plants first located here, they did not even need pumps to get the water out. Now they are installing pumps," said Pedro Gelabert, president of the Puerto Rican government's Environmental Quality Board (EQB). Significant declines in water pressure have been recorded by EQB in Manati and Barceloneta, the center of the industry.
In the south as well, pharmaceutical and other companies have lowered the water table to the extent that salt water is beginning to intrude on fresh water supplies. This process threatens the north coast aquifer. Brackish salty water is fit for neither drinking nor chemical production.
"The main problem with these firms is their effluent (discharge) from production which has to be disposed of in some way," says Tomas Morales Cardona, widely acknowledged as the leading environmental toxicologist on the island.
For many years, waste was dumped directly into the Rio Manati, adjacent to several of the plants, destroying plant life and disrupting the local fishing industry, Morales said. While EQB has clamped down on direct discharge, Morales reported that private companies now pick up the waste from the factories and dump it into the river.
Waste is fed directly into the aquifer in two ways. One is through the sinkholes, which naturally abound along the north coast. "Each company has one or two of these sinkholes on their property," said Morales, "it is one of the reasons for their attraction to the area." The other common practice is the use of injection wells which force wastes deep into the aquifer, two or three thousand feet below the surface. No one knows when that waste will find its way into the drinking supply, according to Morates.
That this danger exists has been admitted by EQB. In a 1974 study the agency said, "The pathway from the point of contamination to the population is very short."
The final method of waste disposal is the use of a barge which sails daily from the port in Arecibo. The firms insist that the barge dumps its waste, said to be the most dangerous of all, 40 miles out to sea. But area resident Nelson Carrasquillo, who works with local fishermen, said as we were inspecting the barge, "We know, because of the time they spend at sea and our observation of the fish catch, that they have been dumping their chemicals as soon as they leave the port."
The companies response to critics of their operations in Puerto Rico is first to deny that they are doing anything illegal.
Then they tend to stress their role as "good corporate citizens." a phrase Sierra of the Pharmaceutical Manufacturers used. Upjohn, for instance, awards science scholarships, donates large sums to the chemistry department at the University of Puerto Rico, and supports a baseball team. According to Sierra, the industry is striving to build up the University of Puerto Rico's School of Pharmacy. The companies are "extremely active in the programs of Academia." he says.
Government officials endorse the role of the pharmaceutical firms in Puerto Rico. A snappy, 30-minute government publicity film entitled Puerto Rico. USA, enthuses over Puerto Rico's transition to capitalintensive manufacturing and boasts that the island has the highest concentration of pharmaceutical plants in the world.
Pharmaceuticals are "a positive force," Bert Finn, a key economic advisor to Governor Romero Barcelo, told me. When asked to explain, he mentioned only one thing: "Workers in these firms are a few notches above the others. They are paid better wages, have better conditions." Finn favors even greater tax-incentives for U.S.-based multinationals.
The government's weak environmental standards testify to its almost blind acceptance of the industry. The Environmental Quality Board maintains good relations with pharmaceutical companies, said Pedro Gelabert, president of the government agency. The companies meet government standards, he says, but admits that his agency relies on industry-supplied data for its evaluations. "We do not have enough inspectors to do it ourselves," he claimed.
While the Puerto Rican government is encouraging the pharmaceutical industry, the U.S. Internal Revenue Service is considering a crackdown. The IRS has been investigating a number of companies for tax violations and, before the Reagan administration came to office, was threatening to prosecute.
The IRS, according to a recent article in Barrons, is worried that the pharmaceuticals may be "working their tax breaks a little too hard." With only 7 percent of manufacturing employees the drug companies earn about half the profits of all tax-sheltered corporations in Puerto Rico.
The IRS estimates that the companies owe the U.S. government taxes on income of around $6 billion. Some of the major violators, according to the agency: G.D. Searle owes $220 million for the years 1974-80; Eli-Lilly is contesting charges of nearly $40 million for the five years ending 1975; and Abbott Laboratories faces a $55 million tax bill for the same period.
There is also a furor over the transfer of patents. IRS regulations stipulate that patent transfer should be done at a fair market price. In other words, if the parent company sells a patent to a subsidiary, that transfer must have some relationship to what the transfer would cost between two non-related firms. This has not been the case in Puerto Rico. When a patent for, say, Darvon, is shifted at little or no cost to a Puerto Rican subsidiary-which the Eli-Lilly Company did in 1966-that subsidiary takes the worldwide profits on an item that was not developed in Puerto Rico and which has no intrinsic link, beyond production, to that part of the firm.
In another case, an internal accounting sheet recently published by the North American Congress on Latin America, shows that Upjohn's Arecibo subsidiary charges Upjohn headquarters $600,000 for 81,500 amputees of cleocin phosphate. This costs the subsidiary only $67,793 to produce. The effect of such practices is to decrease taxable income to the parent and increase profit for the tax-free subsidiary. Independent sources in Puerto Rico showed me similar Upjohn accounting sheets.
Whether or not the IRS goes ahead and presses the point against the island subsidiaries is a source of great speculation in government and industry circles. Many feel that with the Reagan election, and the pro-business climate in Washington, the matter will be quietly dropped.
Bert Finn was worried that firms would back away from investing in Puerto Rico should the IRS choose to enforce its regulations. The governor's office has requested the Reagan administration to evaluate current IRS policies so as "not to prejudice the development of the island," according to Finn.
A recent internal memorandum from the Puerto Rican Economic Development Administration (Fomento) was a bit more optimistic. It stated confidently: "We can expect less harassment of the 936 (i.e. tax-exempt) companies under this administration . . ."
A. Lin Neumann is a freelance journalist based in New York who has recently returned from Puerto Rico. He also works with the United Methodist Seminar Program. .