Over the Labor Day weekend many here in the states may have missed that extensive public demonstrations were taking place in the island territory of Puerto Rico. Residents took to the streets calling for sovereignty, and native entertainers, including Bad Bunny, have been fueling this movement. (Savor the fact that coverage was reported on by an ardent pro-separatist journalist - writing from the U.S.) The reality for the Boricuas may not be something they want, but it is also something highly unlikely, all due to the island’s signature product.
Rum is likely to stall any move for Puerto Rican independence.
Political loggerheads are always going to be in play with a U.S. territory wanting to become independent. Take, for instance, the competing desires that on one side there is the push to break free, while on the other side Democrats are plotting for Puerto Rican statehood, convinced this will give their party more roots inside Washington D.C. Yet there is a bigger issue in play for the island to consider, and that has to do with tax revenues.
Nobody will be the least bit surprised to learn that government involvement and money collection led to a corrupted result. What is at play is essentially a “sin tax”, one applied to spirits production. It is a pernicious dose of political chicanery to realize that often politicians drive us to the point of drinking, and they then profit from the taxes applied to the compelled activity.
Puerto Rico will likely never pull the trigger on forcing independence because that will disengage them from a huge pipeline of federal funding. This involves a complex web of taxes, the Rum Cover-Over, a century-old tax policy that has gradually and unsurprisingly become bastardized over the decades. It is now such a lucrative largesse for Puerto Rico that the territory may have its own version of coconut-scented golden handcuffs.
The Rum Cover-Over was initially established as a means of diverting more revenue into an island territory that the U.S. saw as a loss leader. It began around 1917, about 20 years after the U.S. took possession of Puerto Rico from Spain. Congress passed the Jones-Shafroth Act, legislation that saw fit to have taxes paid by industries on the island diverted from the U.S. Treasury and instead paid directly to the Puerto Rican government. (The wording of the Act stated the funds would “cover” into the Puerto Rican Treasury.)
This new policy would include the taxes paid by rum distillers, in the rate charged to them in the form of a proof-gallon. That tax today is $13.50 assessed for any gallon of rum made at 50% alcohol by volume, or 100 proof. The tax fluctuates based on that alcohol content. For instance, the standard for a bottle of rum is 40% ABV, or 80 proof, so the distiller pays 80% of the tax rate for that proof-gallon, and it would pay above that rate for any rum made at a higher alcohol content.
Things first changed in 1936 when rum maker Bacardi expanded its operations into Puerto Rico. At the time, the distiller was operating on Cuba and Mexico, but moving to a U.S. property would help it skirt tariffs assessed on its product. The company flourished, and about a decade later the local government began its incestuous relationship, since rum production became the largest producer of tax funding.
The decision was made to divert a percentage of those tax revenues to begin the “Rums of Puerto Rico” advertising program. The concept was that the increase in rum sales would generate more Cover-Over tax revenue and compensate for the investment from that tax pool. But this was also a boon for the rum makers, as it was advertising that they did not have to shell out for while increasing their sales volume.
By the 1950s similar legislation was developed for another Caribbean territory, the U.S. Virgin Islands. As this became lucrative, the government of the USVI also saw fit to coddle its rum makers to boost Cover-Over payouts, taking on advertising costs and in the form of price caps on molasses, the base ingredient of rum production. Then came a significant change in the 1980s, and this moved from the imposition of taxes to outright grifting.
When the Caribbean Basin Initiative was passed, one of its provisions was seen as a safeguard for U.S. rum production. Beyond the two island territories collecting taxes on their rum production, now those taxes imposed on rum makers in other countries would also be paid into their Cover-Over tax pool. It meant that other distilleries were paying into the coffers of their competitors.
This new payout format meant the two territories would get a percentage of that pooled funding determined by the rum output between them. At that time, based on the production strength of Bacardi and the makers of Don Q Rum, Puerto Rico was collecting around 85% of the Cover-Over funding. The Virgin Islands decided it wanted to get a bigger share of that new revenue stream.
Their solution was to lure the distiller Diageo, the maker of the popular Captain Morgan brand. They enticed the company by building a new rum-making facility, as well as locking in low molasses costs, backing advertising, zeroing out property taxes, and granting the company a rebate on nearly half of its tax rate. Diageo was able to operate with near-zero production costs as a result.
No shock that this led to other rum producers on both islands beginning to leverage their governments for similar sweetheart deals, demanding their own incentives to either boost production/or to threaten to leave for the competing island. The biggest rum producers out there are now collecting significant cuts of the Cover-Over revenue in a gross case of corporate welfare. This is paid out not to boost flagging operations but as a form of extortion under the threat of leaving for the competition.
While the amount taken in by Puerto Rico annually - just over $500 million - sounds comparatively modest, if they were to achieve independence, the financial strain would become a mounting problem on a territory already operating in the red. That Cover-Over revenue would be cut off. Then its rum producers would have to pay their full freight while the USVI would collect all of the Cover-Over funding, boosting their market position, since Bacardi and others on the island would see increased costs leading to higher prices. Then the likelihood of the distillers fleeing for favorable conditions elsewhere would loom.
This would balloon into a problem that would eclipse a previous effort the island was successful at enforcing, but ultimately led to handicapping the region. In 2003, after lengthy bouts and protests from the residents, the United States Navy closed down the base and operations on the island of Vieques. What was seen as a bold victory has led to local impoverishment, a breakdown of services, and gentrification.
Take that result and expand it across the entire territory of Puerto Rico, an island already impacted by a poor economy, a fleeing population (more Puerto Rican residents live on the U.S. mainland today), a crumbling utility infrastructure, lasting recovery from hurricanes, and diminishing prospects overall. If the people want to divest from the U.S. they need to seriously consider all of the ramifications, because the costs will surely be something they cannot cover.