Tax incentives and entrepreneurship: The case of Puerto Rico

The literature about tax incentive programs is extensive but debate remains regarding the effectiveness of such programs, mainly because of conflicting results.   Nevertheless, when limiting the analysis to smaller areas, incentives seem to be effective.  Thus, by focusing on Puerto Rico (PR), this paper avoids the traditional limitations that emerge when analyzing regions with a mix of incentive programs. 

PR has been a lab for tax incentive programs since the United States (US) took control of the island in 1898.  The development goal has always been to make PR attractive to US capital, and this goal has been achieved by subsidizing the cost of capital by means of tax exemptions. Initially, this vision was somewhat successful allowing PR to escape bottom-of-the-barrel socioeconomic conditions (Poorhouse of the Caribbean). Nonetheless, it has put the island in a peculiar position. PR is not a state but a territory of the US; this allows local residents to escape US taxation but prevents them from full political participation in the US. Although no longer the Poorhouse of the Caribbean, PR is now at the bottom of the barrel once again, but now as the Poorhouse of the US.

The focus of this paper is the Economic Incentives for the Development of Puerto Rico Act (Act 73) of May 28, 2008. According to Puerto Rico Industrial Development Company (PRIDCO), Act 73 was a combination of “aggressive tax incentives for attracting business.”  Act 73's central structure consisted of tax credits linked to the physical location of operations, with lower credits for firms locating inside metropolitan-urban areas (high industrial zones). However, the explicit narrative is new: “attract business” not just US “business.”  Furthermore, by summer 2013 the call for yet another incentive program emerged.  The Support for Microenterprise, Small and Medium Merchant Act (Act 120) of July 2014 was signed into law by the governor.  Act 120 establishes a more significant shift on the type of “business” the government wants to target.

We implement a logit estimation using a data set from PRIDCO with information about all firms locating in PR under Act 73 in 2012 to find potential triggers for Act 120. More specifically, we estimate the likelihood of small firms (Act 120) locating in the targeted areas of Act 73.   We find that small firms as majority, were more likely to locate outside of urban areas and were more likely to be local.