Tomorrow marks the 241st anniversary of the United States’ existence as an independent nation.

I spent last week in a territory that has never enjoyed independence … our Caribbean colony of Puerto Rico, the southernmost part of the U.S.

Earlier this year, I wrote a Bauman Letter report explaining Puerto Rico’s unique tax advantages for U.S. citizens and green card holders, encouraging readers to consider it.

To summarize: If you come to live and/or start an export-oriented business here, you’ll pay 0% federal income tax on Puerto Rico-source income and only 4% to the territory’s government.

In addition, you’ll pay no tax on dividends from your Puerto Rican business, extremely low property taxes and no local capital gains taxes on U.S. (nonretirement) investments or property sales.

Some of my colleagues in the newsletter business thought I was crazy.

Perhaps … but the more time I spend here, the more I’m convinced I’m crazy like a fox.

A Political Poker Game

First, the bad news.

Puerto Rico’s government is bankrupt. Public spending, which plays a huge role in the economy, is declining massively. The electricity utility can’t pay its bills and is falling apart. The population is declining as young, productive families move to the mainland, discouraging investment and reinforcing all the above.

I did a mental exercise whilst steering the boat back from a sailing trip to Cayo Icacos yesterday.

Consumer-based economic development in Puerto Rico is out of the question: The population is too small, mainland imports too cheap. Thanks to federal laws governing minimum wages and similar regulations, agriculture and manufacturing can’t compete with lower-cost producers elsewhere in the region.

An innovative service economy based on finance or company formation is blocked by the same thing: Puerto Rico is part of the U.S., not a freewheeling island nation.

Despite these disadvantages, Puerto Rico isn’t going to fall apart … because of its unique political context.

San Juan holds the cards in negotiations with its Wall Street creditors, and with Washington. The Puerto Rican people aren’t sovereign; Congress is. Even if a debt deal never materializes, if push comes to shove, the island’s government can simply throw up its hands and leave it to Congress to take over.

That would be a very bad thing, and everyone knows it. The rest of the world considers Puerto Rico an unconscionable colonial vestige. The U.S. has gotten away with this only because U.S. citizenship and federal safety-net benefits apply to Puerto Ricans, encouraging the locals to remain loyal.

If the economy collapsed completely, Congress would have no choice but to take over direct administration of the island … in other words, owning the problem, including the debts to Wall Street. Imagine U.S. troops forcibly suppressing protests against the austerity measures required to extract billions of dollars from destitute locals on behalf of Wall Street fat cats.

Ain’t gonna happen. Blackmail isn’t pretty, but it is usually effective.

“It Could Be Worse”: Not Always a Cliché

Now for the good news.

Like its Lesser Antilles neighbors to the east, Puerto Rico is a gorgeous tropical island, albeit much bigger and more varied. Unlike most of those neighbors, however, it has highly developed public and private infrastructure. Despite its debts, Puerto Rico’s government is stable and legitimate. Visitors from the mainland — or from anywhere else — experience “first-world” conditions for the most part.

The island, however, is set up for much larger tourist volumes that the other islands. Given its spectacular beaches, rainforests, fishing and sailing conditions, and similar attractions, there’s no reason why Puerto Rico shouldn’t and couldn’t be a premier vacation and retirement destination for people from the mainland and elsewhere.

Things may be tough, but they’re better than most of the Caribbean, at least as far as mass-market tourism is concerned.

But that would entail some hard choices.

First, the island’s debt would have to be largely written off. The loans never should have been made in the first place. Wall Street knew exactly what it was doing when it made them, taking advantage of rigged federal tax arrangements that made them artificially profitable and assuming it could rely on Congress to do whatever was needed to enforce repayment.

Second, population decline would have to be accepted as natural and desirable. So too would the contraction in economic sectors catering to the permanent population. As hard as it is to accept, there’s just no way to sustain a large population without giving Puerto Rico sovereign control over its situation — which means independence, something only a tiny minority want.

Third, Congress — which has the final say — would have to accept Puerto Rico as our 51st state, as the island’s residents called for in a referendum last month. There is no long-term solution to the island’s problems, financial and otherwise, under the current arrangements.

Can You Benefit?

So where does that leave Puerto Rico’s current tax opportunities for us mainlanders? My take is based on two predictions.

First, Acts 20 and 22 are in no danger under current circumstances. They produce net positive revenue for the cash-starved government — and some of their biggest beneficiaries are Wall Street titans such as John Paulson and Michael Tennebaum, who will lobby like wildcats to protect them.

Second, any changes in this hyperattractive tax regime are likely to wait until statehood — which will probably occur right about the time Acts 20 and 22 expire, in 2035. Even if it occurs before then — unlikely, since it will presumably require a Democratic Congress and White House — there will be plenty of time to benefit from them.

So, as I’ve said before, if the stars align for you and your specific circumstances, you could do a lot worse than to relocate to this lovely island and/or start a business here, and enjoy tax rates unavailable to U.S. taxpayers anywhere else on the planet.

I might just do it myself one of these days.

Kind regards,

Ted Bauman
Editor, The Bauman Letter

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