Not Taxing Puerto Rico? Whitewashing Impoverishment in United States v. Vaello-Madero

Abstract

Puerto Rico is a lush archipelago located between the Caribbean Sea and the North Atlantic Ocean. More than three million U.S. citizens with diverse racial and ethnic histories and cultures live on the islands. But life for Puerto Ricans has been challenging with high rates of impoverishment, disability, unemployment, and devastating natural disasters. In addition to these challenges, Puerto Rico has a complicated relationship with the United States. Indeed, residents, 99 percent of whom identify as Hispanic, are treated “separately and unequally” in many aspects by the federal government compared to their state counterparts. One significant difference is the federal tax treatment of Puerto Rican residents.

This article details the past and present federal taxation of Puerto Rico residents. The article also presents and exposes detailed economic data to demonstrate explicitly that Puerto Ricans are not reaping federal benefits (including tax benefits) as a “welfare island.” In fact, Puerto Rico suffers federal fiscal shortfalls that have been justified by misguided and racist U.S. Supreme Court Insular Cases and their progeny. This analysis establishes that the failure to include most Puerto Rico residents in the federal income tax system has burdened rather than benefited them and their local economy.

I. Introduction

For more than four generations, since 1917, Puerto Ricans have qualified for birthright U.S. citizenship. Yet citizens residing in Puerto Rico do not enjoy the same rights and privileges as citizens residing in the fifty states and Washington D.C., but rather suffer what Justice Ruth Bader Ginsburg famously coined, albeit in the context of marriage, a “skim milk” version of citizenship. Other jurists, scholars, advocates, and politicians, have analogized the systemic discriminatory treatment of U.S. citizens residing in Puerto Rico to the racist “separate and unequal” treatment suffered by communities of color that was deemed constitutional in Plessy v. Ferguson and overturned almost sixty years later in Brown v. Board of Education. This racism arises from the Supreme Court’s interpretation of the Territory Clause of the Constitution in the Insular Cases. The Territory Clause provides Congress with plenary power to “dispose of and make all needful Rules and Regulations respecting the Territory.” The Supreme Court through its decisions in the Insular Cases, decided more than one-hundred years ago, and their progeny has generally held that the Constitution only applies to residents of the territories if Congress has specifically legislated that it applies or if the constitutional right is “fundamental.”

To be clear, many have criticized the Insular Cases. Most recently Justice Gorsuch in his concurrence in United States v. Vaello Madero has described the Insular Cases as a “misguided framework” with a “rotten foundation” arising from the “sordid business of segregating Territories and the people who live in them on the basis of race, ethnicity, or religion” relying on “ugly racial stereotypes, and the theories of social Darwinists.” Gorsuch further explained that the Insular Cases are derived from the racist view that America could “acquire and exploit ‘an unknown island, peopled with an uncivilized race . . . for commercial and strategic reasons’—a right that ‘could not be practically exercised if the result would be to endow’ full constitutional protections ‘on those absolutely unfit to receive [them].’” Other jurists have similarly described this separate and unequal treatment as “odious and wrong” and “an impermissible second rate citizenship akin to that premised on race.” For a stark example evincing the racist treatment of Puerto Rico residents, U.S. Supreme Court Justice Henry Billings Brown (who was also the author of Plessy v. Ferguson) argued that constitutional protections, like uniformity of federal tax laws, should be extended purely to “contigu­ous territor[ies] inhabited only by people of the same race, or by scattered bodies of native Indians” and not in regions “inhabited by alien races, differ­ing from us in religion, customs, laws, methods of taxation, and modes of thought.”

In April 2022, the Court in U.S. v. Vaello Madero reaffirmed this disparate treatment of citizens residing in Puerto Rico in an 8 to 1 decision holding that there was a “rational basis” to deny them equal protection guarantees under the Fifth Amendment and the Territory Clause of the Constitution. The majority opinion written by Justice Kavanaugh overturned the decisions of the District Court of the District of Puerto Rico and the U.S. Circuit Court of Appeals for the First Circuit. The District Court found that targeted racial discrimination against residents of Puerto Rico, who are almost all Hispanic, was the basis for denying Supplemental Security Income (SSI). Both lower courts found no rational basis to deny SSI to otherwise qualifying impoverished, aged, and disabled individuals when they resided in Puerto Rico. The Supreme Court reasoned that residents could not rely on the equal protection guarantee of the Due Process Clause because: (1) some residents of Puerto Rico were not subject to certain income taxes; and (2) providing antipoverty benefits like SSI and subjecting certain Puerto Rico residents to income taxes “would inflict significant new financial burdens on residents of Puerto Rico, with serious implications for the Puerto Rican people and the Puerto Rican economy.” In sharp contrast to the District Court’s scathing decision and to a lesser extent Justice Gorsuch’s concurrence, Justice Kavanaugh’s opinion does not even address claims that this disparate treatment is grounded in racial discrimination. Justice Sotomayor dissented.

Justice Kavanaugh’s majority decision whitewashes the denial of SSI benefits as a rational balancing of federal tax contributions against federal benefits. The Supreme Court’s majority opinion not only ignores race, but also ignores the fundamental flaw in its tax analysis which was explained in detail in the District Court’s opinion; restated by the Court of Appeals in its analysis, and again recounted by Justice Sotomayor in her dissent. Simply put, SSI recipients are necessarily low-income and, therefore, in most, if not all cases, are not required to make any income tax contribution under federal tax law in any of the 50 states and Washington D.C. While all of the opinions detail that residents of Puerto Rico are subject to federal payroll, self-employment, and unemployment taxes consistent with their U.S. citizen state-based resident counterparts, and certain Puerto Rico residents are subject to federal income taxes on all or some of their income, none of the opinions, including Justice Sotomayor’s dissent, explain that by not taxing residents of Puerto Rico the federal government is denying antipoverty tax relief to millions of residents. Given the financial demographics of Puerto Rico residents, if they were subject to the same federal tax laws as state residents, not only would most not pay income taxes, but most would receive meaningful antipoverty benefits including the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC).

This article will explain that by not taxing residents of Puerto Rico the federal government significantly reduces the cost of additional antipoverty benefits that might be due to SSI recipients as well as to the majority of U.S. citizens residing in Puerto Rico. With the increased use of the federal income tax system as a benefits delivery system, not including Puerto Ricans in the federal income tax system does the opposite of the claims made by the majority in its rational basis test analysis. Rather than reducing the federal tax burden on residents, it reduces antipoverty benefits delivered to U.S. citizens merely because of their zip code. Moreover, because residents are subject to regressive payroll and self-employment taxes but are denied the targeted federal offset of earned income tax benefits, they are further harmed. Thus, most Puerto Rico residents are effectively subject to a higher federal tax burden than their 50 state and Washington DC counterparts. This is a distinction that the District Court of Puerto Rico and others have argued is due to the race of the residents, rather than any reasonable fiscal analysis, whether subjected to a rational basis analysis or strict scrutiny.

The primary goal of this article is to expose the irrationality of the argument that because many residents of Puerto Rico are not included in the federal income tax (and tax benefit delivery) system, Congress can rationally deny additional federal benefits to Puerto Ricans. Denying universal antipoverty benefits for disabled and aged individuals under SSI because Congress denies antipoverty and all other tax benefits to most residents of Puerto Rico is not only irrational but unjust. Moreover, given that 99 percent of the residents of Puerto Rico are Hispanic, the District Court’s claim of race-based discrimination must be addressed. Finally, in view of the depth and breadth of tax benefits denied to most of the residents of Puerto Rico by excluding them from the federal income tax system, the truly rational conclusion is that residents of Puerto Rico should be included in the federal income tax system in addition to SSI.

The article commences with an overview of the case of United States v. Vaello Madero. After recounting Mr. Vaello Madero’s story, the article reviews the opinion of the federal District Court of Puerto Rico that holds that the federal government’s denial of Mr. Vaello Madero’s SSI benefits during his Puerto Rico residency was unconstitutional. The opinion explains that denial of SSI benefits is not rational under equal protection guarantees, but rather is unconstitutional race-based discrimination. The article next reviews the First Circuit Court of Appeals’ opinion and its rejection of the denial of SSI benefits. The Court of Appeals found that the government’s arguments supporting the denial of SSI to otherwise qualifying residents of Puerto Rico were arbitrary and capricious. Following this analysis, the article compares the lower courts’ tax analysis and contrasts them with the Supreme Court majority and dissenting opinions. Next, the article provides a brief historical background of Puerto Rico’s economy generally and the application of federal taxes to its residents and businesses specifically. The article concludes by demonstrating that the separate and unequal “not taxing” of Puerto Rico has undermined its economic well-being leaving residents impoverished and suffering extreme economic inequality. Faced with this profoundly adverse and racially disparate economic treatment, Congress expanded certain federal income tax benefits to residents of Puerto Rico during the pandemic and provided funding for Puerto Rico’s EITC. In conclusion, I join experts and a majority of Puerto Ricans who agree that it is time for Puerto Rico to become a state to end the continuing injustice of unequal treatment to millions of U.S. citizens residing in Puerto Rico.

II. United States v. Vaello Madero

Jose Luis Vaello Madero is a U.S. citizen who was born in Puerto Rico in 1954. He moved to New York when he was in his early 30s and lived and worked there for more than 27 years. In 2012, he became seriously ill leaving him incapacitated so he applied for and received SSI disability benefits. These payments were deposited directly into his New York bank account until the government ceased the payments. In July 2013, Jose Luis moved back to Puerto Rico to care for his ill wife who had moved there when her health started to fail. In June 2016, Jose was approaching his 62^nd birthday so he applied for Social Security retirement benefits on his work earnings record. Upon learning from Mr. Vaello Madero that he had moved to Puerto Rico, within two months the Social Security Administration (SSA) stopped his monthly SSI payments and notified him in writing that it had reduced the amount of his allowable SSI benefits from August 2013 through August 2016 to $0.

More than a year later in August 2017, the United States sued Vaello Madero for $28,081 in overpaid SSI benefits (plus interest, attorney fees, and costs). Less than a week after the case was filed, Mr. Vaello Madero, who was a disabled senior caring for his ill wife in Puerto Rico, signed a stipulation for consent judgment without representation or the advice of counsel. Shortly thereafter, together with a court-appointed pro bono lawyer, Vaello Madero moved to withdraw the stipulation. The United States responded by moving to dismiss the case without prejudice. The District of Puerto Rico denied the request for dismissal in May 2018, reasoning that because the United States had initiated and filed the lawsuit they could not ask for a dismissal once the defendant was represented by counsel and withdrew his stipulated consent judgment.

In December 2018, both parties returned to the District Court of Puerto Rico in San Juan and argued competing motions for summary judgment. Counsel for Mr. Vaello Madero argued that the exclusion of Puerto Rico residents from SSI violates equal protection guarantees of the Due Process Clause. The U.S. argued that Congress’ “eligibility requirements for government benefits hold a strong presumption of constitutionality” and that its “authority under the Territorial Clause enables it to pass economic and social welfare legislation for the territories where there is a rational basis.”

A. District of Puerto Rico 2019 Opinion

On February 4, 2019, the District Court of the District of Puerto Rico, held that “allowing a United States citizen in Puerto Rico that is poor and disabled to be denied SSI disability payments creates an impermissible second class citizen akin to that premised on race.” The court reasoned that United States citizens residing in Puerto Rico “are the very essence of a politically powerless group” with no rights to vote for representation in Congress or the President. The court agreed with the U.S. Supreme Court’s decision in United States v. Windsor, stating that “[t]he Constitution’s guarantee of equality ‘must at the very least mean that a bare congressional desire to harm a politically unpopular group cannot’ justify disparate treatment of that group.” The court found that denying SSI benefits to individuals merely because they reside in Puerto Rico, or similarly Guam and the United States Virgin Islands, that are overwhelmingly not white, is a violation of “basic due process” principles as it inflicts an “injury and indignity” and is never a valid reason for disparate treatment of fundamental rights. The court held that “federal legislation that creates a citizenship apartheid based upon historical and social ethnicity within the United States’ soil” is unconstitutional.

With this strong holding, it is not surprising that the District Court was not convinced by the government’s arguments that (1) providing SSI would be costly, and (2) Puerto Rico residents don’t pay federal income taxes. The court explained that providing SSI benefits to medically needy and poor Puerto Rico residents is a minimal cost in the context of the entire program. The court further countered the government’s cost and tax contribution arguments by noting that a significant percentage of residents of Puerto Rico must and do pay federal taxes. The court also remarked that if Congress was concerned with the actual costs of SSI its exclusion of Puerto Ricans could not be justified.

The District Court explained that in addition to millions of citizens, hundreds of thousands of noncitizens in the states, District of Columbia, and the Commonwealth of the Northern Mariana Islands qualify for and receive billions of dollars of SSI benefits annually. The number of noncitizen SSI beneficiaries has been as high as 785,410 in 1995 or about twice as high as the number of citizens residing in Puerto Rico who would otherwise qualify for SSI. In December 2021, 365,714 noncitizens, or almost 5 percent of all SSI beneficiaries, received an average monthly benefit of $503.75 or more than $184 million in monthly benefits. Citizens residing in Puerto Rico (American Samoa, Guam, and the U.S. Virgin Islands) are considered “outside the United States” and cannot qualify for any SSI benefits despite higher percentages of seniors and people living in poverty or with disabilities. Similarly denied are SSI benefits for individuals who have certain outstanding warrants or felonies or are residing in a jail, prison, hospital, skilled nursing facility, nursing home, intermediate care facility, halfway house, public emergency shelter, or any other kind of institution. This exclusion from SSI is consistent with the “foreignness” treatment and racialization of Puerto Ricans that undermine their rights as U.S. citizens.

The District Court reasoned that denying SSI benefits to a group of the poorest and medically neediest U.S. citizens because they reside in Puerto Rico is irrational differentiation and, therefore, unconstitutional unequal treatment. The court held that excluding residents of Puerto Rico from SSI benefits denied their right to equal protection under the Constitution. The District Court granted Mr. Vaello Madero’s summary judgment motion finding that the SSI benefits received during the time he resided in Puerto Rico were proper and correspondingly denied the government’s cross motion for summary judgment.

B. Decision of the Court of Appeals for the First Circuit

The government appealed the District Court of Puerto Rico’s decision to the United States Court of Appeals for the First Circuit. After a de novo review, on April 10, 2020, the court affirmed the district court’s grant of Mr. Vaello Madero’s summary judgment motion and denied the government’s cross motion for summary judgment. Using a different methodology than the District Court in its analysis, the First Circuit similarly held that there is no rational basis for denying residents of Puerto Rico SSI benefits. In its opinion the First Circuit rejected the methodology used by the District Court, but similarly found racial prejudice, and concluded that denying SSI to Puerto Rico residents “discriminates on the basis of a suspect classification because ‘[a]n overwhelming percentage of the United States citizens [who] resid[e] in Puerto Rico are of Hispanic origin.’”

The First Circuit acknowledged the District Court suggestions that the precedents cited by the government – specifically the U.S. Supreme Court decisions in Califano v. Gautier Torres and its sequel Harris v. Rosario – need to be reviewed given that they have “suffered erosion by the passage of time” and “changed circumstances.” However, the First Circuit explained that Supreme Court precedents remain binding until it overrules them. Nevertheless, the Court of Appeals concluded that even considering these cases as binding precedent, given that they were not precisely on point to the issues presented, Congress’ denial of SSI benefits to residents of Puerto Rico failed to survive a rational basis review for equal protection.

The First Circuit found no merit in the government’s arguments that Congress can rationally deny aged, disabled, blind and impoverished residents of Puerto Rico SSI benefits because of the costs of extending them or because such residents “do not, as a general matter, pay federal income taxes.” The court first addressed the federal income tax analysis and noted that the Supreme Court was incorrect in Califano when it stated that Puerto Rico residents “do not contribute to the federal treasury.” The court explained that Puerto Ricans do contribute to the federal treasury and have made contributions equal to more than $4 billion annually from 1998 through the beginning of the recession in 2005 and more than $3.4 billion in 2018. These annual federal treasury contributions are a result of the imposition of federal income and payroll taxes on Puerto Rico residents including income taxes on non-Puerto Rico source income and on all federal employees, as well as Social Security, Medicare, and Unemployment Compensation taxes on all wages and self-employment income. The court noted that at least six states and the Commonwealth of Northern Mariana Islands have qualified for SSI benefits even though they each contributed less annually to the U.S. Treasury than Puerto Rico. These states, including Vermont, Wyoming, Montana, North Dakota and South Dakota, also had two voting Senators and at least one member of Congress in the House of Representatives representing their interests. Furthermore, their residents are able to vote for the President and Vice President of the United States. The court ended its tax analysis by highlighting that residents of the Commonwealth of Northern Mariana Islands qualify for SSI benefits even though the residents enjoy more expansive exclusions from federal taxation than residents of Puerto Rico.

The court also addressed the government’s second argument that the cost of SSI for residents of Puerto Rico is justification for excluding them. The court reasoned that “costs alone” cannot be a rational basis for excluding disabled, aged, blind, and impoverished individuals from SSI. The court explained that providing SSI benefits, a last resort minimal financial safety net for the most medically needy and vulnerable individuals, necessarily imposes a cost on governments and, therefore, cannot be a reason for denying the benefit. After the First Circuit’s step-by-step scrutiny and analysis of the record and any “conceivable theoretical reasons” for Congress’ disparate treatment, it concluded that the “categorical exclusion of otherwise eligible Puerto Rico residents from SSI is not rationally related to a legitimate government interest.”

C. U.S. Supreme Court Opinion

1. The Majority Opinion by Justice Kavanagh and the Two Concurrences

The government sought and the U.S. Supreme Court granted certiorari. The Supreme Court heard the case in November of 2021 and issued its decision and opinion on April 21, 2022. In a short five and one-half page decision the Court held that the equal protection component of the Fifth Amendment’s Due Process Clause does not require Congress to provide SSI benefits to otherwise qualifying residents of Puerto Rico. The Court reversed the lower court’s decision “[i]n light of the text of the Constitution, longstanding historical practice, and this Court’s prece­dents.” The Court, relying on Califano and Harris, found a reasonable basis to deny SSI benefits because “residents of Puerto Rico are typically exempt from most federal income, gift, estate, and excise taxes.” In contrast to the lower courts’ analysis, the Court found that it was reasonable for Congress to take into account the benefits to and the burdens on the residents of Puerto Rico. Moreover, the Court foreshadowed an “extreme” financial burden if the Constitution were to require equal protection of residents of Puerto Rico and provide SSI benefits to qualifying individuals because it would require “inflict[ing] significant new financial burdens on residents of Puerto Rico, with serious implications for the Puerto Rican people and the Puerto Rican economy.”

In explaining its decision, the majority failed even to mention concerns raised regarding racial discrimination or the unique challenges facing disabled, blind, aged, and impoverished Puerto Ricans who would not be burdened with federal income taxes even if imposed, or the significant amount of federal taxes that Puerto Ricans contribute to the U.S. Treasury. Instead, in a brief opinion supporting an 8-1 decision, the Court decided that Mr. Vaello Madero, a U.S. citizen, had to pay back more than $28,000 of otherwise qualifying SSI benefits received after he moved to Puerto Rico. Simply put, Justice’s Kavanaugh’s majority opinion whitewashes the racist treatment of Puerto Rico’s most vulnerable residents. In contrast, Justice Gorsuch’s thoughtful concurrence details the racist history of the Insular Cases and expressly calls for them to be “squarely overruled.” However, Justice Gorsuch joins the majority decision “[b]ecause no party asks us to overrule the Insular Cases to resolve today’s dispute.” Justice Thomas joined the majority through a lengthy concurrence that describes his disagreement “with the premise that the Due Process Clause of the Fifth Amendment contains an equal protection component whose substance is “precisely the same” as the Equal Protection Clause of the Fourteenth Amendment.” Justice Sotomayor dissents.

2. Justice Sotomayor’s Dissent

Justice Sotomayor’s dissent begins with a brief recounting of the structural history of SSI by focusing on its transition to a federal government program fifty years earlier in 1972. She explains that SSI is “a fully nationalized assistance program with federal administration, federal determination of eligi­bility, and financed entirely from federal funds,” specifically resources from the U.S. Treasury general funds. Justice Sotomayor further details that SSI “establishes a direct relationship between the recipient and the Federal Government” where “recipients apply for assistance directly to the Federal Government, and the Federal Government disperses funds directly and uniformly (using national eligibility criteria) without regard to where claimants reside.” Justice Sotomayor explains that because SSI is designed and structured as a federal benefit the residence of the recipient within the states and territories should be a distinction without a difference. However, Mr. Vaello Madero’s change of residence to Puerto Rico was the sole factor undermining his access to SSI benefits.

Justice Sotomayor details the history of the litigation describing the District Court of Puerto Rico’s summary judgment for Mr. Jose Luis Madero Vaello and the First Circuit’s unanimous affirmation of that decision after de novo review. Observing “that SSI is a ‘national program’ that is operated and administered uniformly, with­out regard to” residence, the Court of Appeals found no rational basis for denying SSI to residents of Puerto Rico. Finally, Justice Sotomayor turns to the analysis of the majority decision of the Court.

Sotomayor notes that the Court applied a rational basis test to determine if Congress’ denial of SSI to U.S. citizen residents of Puerto Rico is constitutional under the equal protection guarantee of the Fifth Amendment. She recounts that the Court simply accepted that “Puerto Rico’s ‘tax status’ provides a rational basis for ex­cluding citizens who reside in Puerto Rico from the SSI pro­gram.” However, the Court ignored the Court of Appeals’ conclusion that it is “antithetical to the entire premise of the [SSI] program to hold that Congress can exclude citizens who can scarcely afford to pay any taxes at all on the basis that they do not pay enough taxes.” Similarly, Sotomayor argues that it is irrational to use residency to deny benefits when residency has zero bearing on any aspect of the program. In conclusion, Sotomayor finds that Congress’ decision to exclude millions of U. S. citizens who reside in Puerto Rico from the SSI program is irrational and patently unconstitutional. Given this targeted exclusion based solely on location, an understanding of the historical and current status of Puerto Rico is vital.

III. Puerto Rico

The unique history and character of the people and place of Puerto Rico is of paramount importance in reviewing each forgoing opinion and is critical to the differing analyses. Therefore, this Section will detail the history of Puerto Rico and the United States, including with respect to federal tax laws. Additionally integral to a complete understanding of the issues are the unique characteristics of the U.S. citizen residents of Puerto Rico. Their noteworthy demographics are foundational to the tax analysis and arguments made by the courts. Framing a review of the questions presented by Vaello Madero in the exceptional history and the demographics of the American citizens residing in Puerto Rico is critical to serving justice. Context is foundational here because the U.S. citizens in Puerto Rico suffer impoverishment, disability, and deprivation of food, housing, and health care at rates that overwhelm even the worst economic conditions in the 50 states and Washington D.C. Moreover, given the gross economic disparities in the context that 99 percent of Puerto Ricans are Hispanic, race and ethnicity are crucial to the legal analysis.

Race and ethnicity are complex social constructs. But they are even more complicated in Puerto Rico because of its colonial past; indigenous, African, and European roots; its experience of historical slavery; and the strong ethnic “Puertoriqueño” culture. Post-slavery, most Puerto Ricans perceived themselves as Hispanic and as racially white. There has been and still is resistance among many Puerto Ricans to racially identifying with African heritage. Social scientists have found that Puerto Ricans generally affiliate Blackness with slavery. The colonized condition of Puerto Rico through its substandard educational systems and other institutions have not afforded full acknowledgment of the atrocities of slavery. Passing as white and “whitening/blanqueamiento” represents a cultural practice that was commonplace in Spain and, in turn, Puerto Rico.

Racial categories in the United States are not reflective of the racial identities embodied by Puerto Ricans. In Puerto Rico racial identification is neither binary, absolute, nor as paramount and divisive as it is in the states. In the states and D.C., under the hegemony of the “one drop” rule, all Puerto Ricans are generally categorized as Black. By comparison, scholars find that contemporary Puerto Ricans perceive themselves as a mixture of their three ancestral “races”: Indigenous, Spanish, and African. However, scholars and activist also acknowledge and describe hundreds of years of island elite encouraging whiteness and anti-Blackness to gain white privileges. Consequently, about fifty percent of Puerto Ricans still self-identified as white in the 2020 census even though much of the population has African and Indigenous roots. However, Puerto Ricans’ self-identification as “white” has significantly decreased since the last two censuses when more than three-quarters (2010) and 80 percent (2000) of Puerto Ricans self-identified as white. Prior to 2000, beginning in about 1970, the government had intentionally excluded the question of racial identity from the census because the categories did not comport with Puerto Rican self-identification. Today, demographers, scholars, and activists continue to work with Puerto Ricans to better understand, evaluate, and research issues regarding racial and ethnic identification on the island and in the states.

Systemic racism has resulted in hundreds of years of economic injustices causing unrelenting financial hardship in Puerto Rico that exists through present day. Residents of Puerto Rico qualify for fewer and lower federal benefits. These facts are indisputable, relevant, and must not be ignored or whitewashed. This is especially relevant in the context of Mr. Vaello Madero, a Hispanic U.S. citizen, who is necessarily among the most vulnerable of all Americans as an impoverished, and disabled senior who qualified for SSI before moving back to his birthplace.

In sharp contrast to the economic deprivation and racial discrimination suffered by the residents of Puerto Rico, the islands that comprise the territory are lush with mountains, waterfalls, beaches, and rain forests. Puerto Rico is actually an archipelago, or a group of islands, formed by the main island and 143 small islands, islets, and cays. The main island of Puerto Rico is about 3,000 square miles measuring approximately 100 miles from east to west with an average width of 34 miles. The main island is three times the size of Rhode Island and is located 1,100 miles from Key West, Florida, juxtaposed between the Dominican Republic and the British Virgin Islands in the Atlantic Ocean.

In 2022 the U.S. Census Bureau reported that over 3.2 million people lived in Puerto Rico, making it more densely populated than any of the 50 states and Washington D.C. with almost 960 residents per square mile. However, due to recent waves of migration, more Puerto Ricans live in the continental U.S. than in Puerto Rico. Unrelenting natural disasters, bleak business opportunities, and disparate federal treatment have driven these departures, further depressing economic activity, decreasing resources for schools and other institutions, and leaving fewer workers to support necessary needs and services. Puerto Rico’s economic problems are deep and broad, but grounded in its historical posture as a colony. The next Section will recount this complex and tormented history.

A. Brief History of Puerto Rico

Puerto Rico is one of the oldest colonies on earth as it has been under military occupation or protective status for more than 500 years. In 1493, Spain, through Christopher Columbus, claimed Borikén, “the land of the brave lord,” home to about 30,000 indigenous Taíno people. Borikén, which Columbus renamed San Juan Bautista, became a critical military outpost for Spain in defense of its New World Territories. In 1508, seeking to reap the wealth of the island, Ponce de León sought and was granted the right to explore for gold and subjugate the island people. He quickly took control, forcing the Taíno people to slave in gold mines and vast sugarcane plantations. As a result of forced servitude and similar inhumane treatment, the indigenous Taíno people were nearly exterminated by disease (smallpox, influenza, measles, and typhus) and exhaustion. Despite this atrocity Spain was not deterred in its exploitation. In 1513, enslaved Africans were imported to toil in the gold mines. Although the gold reserves were nearly depleted by 1540, institutionalized slavery endured in Puerto Rico until 1873.

By the 19th century, the island which Spain renamed Puerto Rico, or Rich Port, was an economic powerhouse resulting from slave labor producing profitable sugarcane, coffee, and tobacco crops. Descendants of Spanish colonists, free and enslaved Africans, and the few remaining Taíno people pushed for freedom from Spanish rule. In response to these demands for liberation, Spain granted Puerto Rico some independence in 1897.

The United States also reaped riches from Spain’s Caribbean islands and its enslaved people. U.S. capitalist had significant investments in and connections to sugarcane plantations which caused friction with Spain over tariffs and related costs. This friction escalated with the explosion of the U.S. Battleship Maine in Havana, Cuba in February 1898, which resulted in the death of 266 men. After an initial Court of Inquiry determined that the explosion was likely due to a mine, the U.S. House of Representatives (311 to 6) and Senate voted (42 to 35) to adopt a Joint Resolution for War with Spain. President McKinley signed the resolution, and war ensued between the U.S. and Spain in April 1898. Notably, subsequent reviews of the wreckage more than 75 years later by maritime experts found that the explosions sinking the Maine were more likely from internal rather than external forces.

In July 1898 President McKinley ordered the army to invade and occupy Puerto Rico. These efforts were successful, and by the end of the month the Spanish government notified President McKinley that it wanted to suspend hostilities and negotiate peace. The negotiations took place in France and resulted in the Treaty of Paris ending the Spanish-American War of 1898. Spain ceded Puerto Rico and Guam and sold the Philippines to the U.S. for $20 million. Cuba was granted independence.

Nevertheless, for the next two years the U.S. operated Puerto Rico under military rule. In 1900, Congress passed the Foraker Act, and President McKinley signed it into law, establishing a distinct civilian Puerto Rican government under U.S. supervision and control. The Act provided for local government leadership, including a governor and legislative bodies predominately appointed by the President, the application of all federal laws to the territory, a judiciary, and a nonvoting representative in Congress. The Foraker Act also imposed limited tariffs on goods exchanged between the U.S. and Puerto Rico.

In 1917, President Woodrow Wilson signed the Jones-Shafroth Act granting U.S. citizenship to persons born in Puerto Rico. The Jones-Shafroth Act also created the Puerto Rico Bill of Rights and established the Office of the Resident Commissioner in Congress, with the representative serving a four-year term. The Resident Commissioner is elected by Puerto Ricans, but the Commissioner does not have a vote in the House, although they may sit on and vote as other Congressional committee members. Residents of Puerto Rico, while U.S. citizens, are not eligible to vote in general elections for the President or Vice President of the United States. However, they do currently have delegates (and vote) for presidential primary candidates. Puerto Ricans have no other representation in Congress.

In 1947, Congress redelegated gubernatorial appointments to the people of Puerto Rico, and in 1952 it approved Puerto Rico’s constitution recognizing it as the Commonwealth of Puerto Rico. Since 1952, the Commonwealth of Puerto Rico has enjoyed economic booms and busts resulting in significant migration of residents to the 50 states and Washington D.C. Puerto Rico has suffered and continues to suffer increasingly deadly and destructive hurricanes that have overwhelmed residents, the infrastructure, and the economy. Today, more Puerto Ricans live outside of the Commonwealth than on the island.

For decades Puerto Rico’s government has operated with a deficit funded by tax advantaged public debt. In 2002, Puerto Rico’s debt was 42 percent of Gross Domestic Product (GDP) and 67 percent of its Gross National Product (GNP) increasing to 66 percent and 99 percent, respectively, by 2014. In addition to these debt obligations, Puerto Rico has significant unfunded pension obligations for its public employees. In 2016, in response to Puerto Rico’s default on $1.5 billion in debt and exploding debt obligations, including more than $72 billion in debt and $55 billion in unfunded pension obligations, President Obama signed into law the Puerto Rico Oversight, Management, Economic Stability Act (PROMESA). The Act created the Puerto Rico Financial Oversight and Management Board (FOMB) consisting of seven voting members appointed by the President and the Governor of Puerto Rico, who serves as an ex officio member with no voting power. FOMB has broad authority to “supervise and modify Puerto Rico’s laws (and budget).”

Specifically, FOMB has the authority to determine Puerto Rico’s “fiscal plan,” including all revenues and expenditures which “shall provide a method” to achieve “fiscal responsibility.” Puerto Rico’s governor may propose fiscal plans, but FOMB retains “sole discretion” for approval. FOMB’s “fiscal plan” controls Puerto Rico’s budget approvals. If the governor and legislature submit noncompliant budgets, FOMB may set the budget itself. Any spending that is inconsistent with the FOMB-certified budget may be denied other than for debt service. In early 2022, FOMB oversaw and received a federal court’s approval of a bankruptcy plan that reduced the Commonwealth of Puerto Rico’s debt of about $33 billion in debt and $55 billion in unfunded pension liabilities by 80 percent. FOMB will remain in place until Puerto Rico has achieved four consecutive years of balanced budgets and access to credit at reasonable rates.

By mid-2022, private-sector employment in Puerto Rico reached a fifteen-year high with medical manufacturing, tourism, and an emerging aerospace industry providing jobs. Unfortunately, wages remain low at about one-half of stateside amounts. Costs of goods and services and inequality remain high. Integral to Puerto Rico’s history is its federal and Commonwealth tax structure. The next Section details the taxation of Puerto Rico businesses and residents from approximately 1900 to the present.

B. Taxing Puerto Rico

1. Federal Control Over Taxation in and of Puerto Rico

For more than one hundred and twenty years, the United States “has practiced an understudied form of economic imperialism in Puerto Rico.” This Section will recount the progression of these U.S. and Puerto Rico tax structures over time. After the United States took possession of Puerto Rico at the turn of the 20^th century, it dismantled the existing tax structure and imposed its own to serve U.S. economic interests, leaving Puerto Rico in a persistent state of scarcity and hardship. The predominate fiscal tool to control the Commonwealth has been using tax laws to advance corporate economic interests. Similarly, these tax structures have imposed racial oppression at a significant cost to Puerto Rico’s independence, fiscal well-being, and the health, safety, and daily lives of residents. The U.S. rewrote Puerto Rico’s tax laws to reduce taxation of U.S. corporations doing business there, which in turn increased taxation of Puerto Rican consumers, landowners, and native businesses.

The first significant U.S.-Puerto Rico tax provisions were new tariffs that were included in the Foraker Act of 1900 on certain goods exchanged between the U.S. and Puerto Rico for a two-year period. Puerto Rico was entitled to these tariffs for its own treasury together with tariffs on traditional international trade. Under the Act, U.S. internal revenue laws, had no force and effect in Puerto Rico. At that time internal revenue laws did not include income taxes, but rather were predominately excise taxes on alcohol, tobacco, and playing cards. The primary benefactors of this revised tax system were large U.S. corporations, including most significantly powerful sugar refiners. This period has been described as the “crypto-plantation period” with mega-mainland businesses reaping annual returns on investments of 115 percent. These businesses harvested raw materials and avoided not only recently-repealed Puerto Rico income and other revenue-raising taxes, but after two years, also the expiring tariffs on imports and exports. With increasing power, U.S. corporations had lobbied Congress to eliminate tariffs, though tariff repeal would position Puerto Rico to suffer severe revenue shortfalls.

In an attempt to mitigate these shortfalls, the U.S. imposed direct real property taxes on landowners in Puerto Rico. These taxes were opposed by many locals because they were inconsistent with the prior indirect tax structure including the income taxes that predated U.S. control. Moreover, the pervasive perception was that assessments and enforcement advantaged U.S. corporate interests with lower appraisals for land used for growing sugar cane, coffee, and tobacco relative to Puerto Rican-owned farms and forestland. These expensive property taxes forced locals to sell and commercialize their landholdings, further serving large U.S. corporate economic interests.

Shortly after enactment of the new taxes, litigation arose over the lack of uniformity in the different tax treatment of Puerto Rico compared to the states, which was at odds with the requirements of the Uniformity Clause of the U.S. Constitution. In 1901, in the first of what later became known as the Insular Cases, the Supreme Court held that Congress had the authority to create non-uniform revenue laws for “unincorporated” territories including Puerto Rico because the residents were not racialized as white. The Court stated that because the residents of Puerto Rico were “alien races, differing from us in religion, customs, laws” that “the administration of government and justice, according to Anglo-Saxon principles” was not possible and that Puerto Rico would be treated as “foreign to the United States in a domestic sense.” This and similar racist framing of Puerto Ricans as not worthy of constitutional protections is characteristic of the Insular Cases. These decisions have defined and exposed the racist separate and unequal status of Puerto Rico and its subsequent relationship with the United States.

With the complete repeal of export tariffs, Puerto Rico suffered even greater fiscal shortfalls. In yet another attempt to mitigate these losses, Congress extended the federal corporate income tax of 1909 and individual income tax laws of 1913 and 1916 to Puerto Rico. While these were federal income taxes, the revenue collected went to Puerto Rico’s government treasury. Unfortunately, income tax revenue and collections were dismal at only $67,000 in 1913 and $78,000 in 1914, increasing to $500,000 in 1916 and 1917. This tax revenue was not adequate to fill the significant fiscal void from tariff repeal.

In March of 1917, Congress enacted the Jones-Shafroth Act granting, among other rights, broader taxing powers to the Puerto Rico government, although subject to Congressional review and veto. In response to enhanced legislative powers and the continued need for revenue, Puerto Rico enacted a local income tax in addition to existing federal income taxes. In response, Congress pushed back in its continued attempts to maintain Puerto Rico as a tax haven for U.S. businesses through a federal tax credit under the Revenue Act of 1918. The tax credit was equal to any income taxes paid to foreign countries, as well as any of the U.S. possessions. By 1920, Congress was even more vigilant regarding concerns of double taxation in Puerto Rico despite similar state level taxation. Ignoring the similarities, Congress pushed Puerto Rico to restructure the U.S. and territory tax systems into a unified tax with a federal tax credit offset for U.S. domestic corporations. The tax rate was three percent on the income of residents and corporations, as compared to a six percent rate on nonresidents and foreign corporations, including U.S. corporations doing business in Puerto Rico with a foreign tax credit against any federal tax liabilities.

Despite this tax windfall, businesses with Puerto Rico source income continued to lobby Congress for a full federal income tax exclusion. In the Revenue Act of 1921, Congress exempted certain income derived from U.S. possessions from all federal income taxes, explaining that the “double tax burden [had] placed American businesses at a competitive disadvantage when compared with their British and French counterparts.” While these tax exemptions were generous to U.S. businesses in Puerto Rico, the Great Depression, together with hurricanes, devastated island agricultural production including sugar, coffee, and tobacco and left the Puerto Rico treasury and its people shattered.

In the late 1940s, in an effort to diversify its economy, Puerto Rico sought investments from new industries and jobs by implementing “Operation Bootstrap.” Operation Bootstrap offered U.S. corporations at least ten years of exemption from Puerto Rican income and property taxes, as well as from most excise taxes, municipal taxes, and license fees. In 1954, the federal government expanded the possessions tax exemption to include the remaining U.S. territories. The resulting amended and restated law was codified as Section 931. When combined with the federal income tax exemption, U.S. corporations avoided all forms of taxation and enjoyed a substantial windfall.

As global and domestic competition for business and investment capital increased, Puerto Rico was the focus of significant backlash for following Congress’ lead and providing economic benefits for U.S. businesses and positioning itself as a tax haven. In response to criticism from states and other competitors for capital, in 1976 Congress repealed the exclusion for corporate source income derived from U.S. possessions but once again implemented an income tax credit for corporations to provide a more efficient system of exempting corporations from income taxation on their possession-sourced income. The Section 936 possession tax credit served U.S. corporations similar to its predecessor Section 931. While initially positive, the resulting local economy added different but similarly aggressive tax-minimizing businesses including the pharmaceutical industry, that were attracted by and dependent on generous tax incentives.

The pharmaceutical industry, which relies on valuable intangible assets in drug patents to generate profits, was particularly well suited to reap enormous benefits from Puerto Rico’s tax favorable structure. The General Accounting Office determined that about 50 percent of Section 936 tax benefits, or in excess of $10 billion for the eleven years from 1980 to 1990, inured to this one industry while generating only 20 percent of the corresponding jobs. These companies developed patents in the U.S., which allowed them to enjoy research and development tax deductions in the states, and then transferred the patent to be manufactured and sold in Puerto Rico, which allowed them to reap a lucrative income tax exclusion. In addition, aggressive transfer pricing shifted higher costs to the states and higher profits to operations in Puerto Rico, which further increased the income tax benefits.

In an effort to bring billions of dollars of accumulated tax-exempt earnings back to the states from foreign and possessions coffers, Congress amended federal tax laws to provide a 100 percent dividends-received deduction to encourage repatriation that had been stalled by adverse tax consequences. To stop this outflow of capital, Puerto Rico enacted a tollgate tax to apply to the repatriated earnings. The tollgate tax did discourage billions of dollars of outflows. The push and pull of attracting businesses and capital continued through 1996 when Congress enacted the Small Business Job Protection Act of 1996 phasing out Section 936, the possession tax credit, over a ten-year period.

There has been significant debate about the benefits and burdens of Section 936 to the economy and people of Puerto Rico given the significant cost to the U.S. Treasury. Annual lost revenues ranged between $3.9 billion and $4.8 billion. The Joint Committee on Taxation has estimated that federal revenues forgone were $3.9 billion in 1994. During the twenty years from the enactment of Section 936 in 1976 to the start of its phase out in 1996, Puerto Rico’s real GNP grew at an annual average rate of 2.5 percent as compared to 3.0 percent for the states. However, the growth rate of Puerto Rico’s GDP was considerably higher at 3.5 percent than U.S. GDP at 2.3 percent during the 20 year period from 1971-1991. In 1987, experts have estimated that it cost the U.S. government at least $1.51 in average lost tax revenue for each $1.00 in wages paid in Puerto Rico. Thus, on average it cost at least $26,725 for an annual salary of $17,725. For the pharmaceutical industry, the amounts were $3.08 per $1.00 in wages, or $81,483 for a job paying only $26,471. Many economists agree that as a result of the fiscal windfall of the federal tax credit for businesses based in Puerto Rico, it is not surprising that there were decreases in investments and jobs causing a decline in economic activity and tax revenues for the Commonwealth after repeal. However, because of the heavy cost of Section 936 to the U.S. Treasury and the lack of equivalent fiscal benefits to Puerto Rico, many also agree that the final repeal in 2006 made fiscal sense.

In conjunction with the contraction of the economy, lower tax revenues, and high rates of expenditures on unrelenting hurricane damage, the Puerto Rico government borrowed heavily using tax advantaged debt resulting in unsustainable levels of debt, interest, and payments. Tax-advantaged debt was an early fiscally disastrous tax policy launched in 1917 when Congress provided tax exemption from federal, state, and local taxes for Puerto Rico bonds in the Jones-Shafroth Act. Triple tax exemptions made Puerto Rican government bonds highly attractive at a time when investors were looking for investment opportunities. This also provided access to the ready debt markets at a time when Puerto Rico was struggling to fill the deficit covering its general obligations. As tax revenues continued to decline and debt limits loomed, the Puerto Rico government sought alternative financing sources, including the securitization of sales-tax-revenue streams to avoid constitutional debt limits. As a result, public debt soared from $39.2 billion in 2005 to $71 billion in 2016. Eventually Puerto Rico could no longer service its debt, but federal law did not allow Puerto Rico to restructure.

Puerto Rico’s credit rating dropped to below investment grade, followed by a series of debt payment defaults. In 2016, the financial crisis resulted in Congressional intervention through PROMESA establishing the FOMB which provided the framework for restructuring Puerto Rico’s debt. By April of 2023, the Oversight Board, together with the Government of Puerto Rico, had successfully restructured about 80 percent of outstanding Puerto Rico debt, reducing total liabilities from more than $70 billion down to $37 billion and reducing debt service payments by $50 billion. The debt restructuring process continues imposing strict government spending constraints resulting in reduced resources and higher costs of living.

2. Current Federal Tax Status for Puerto Rico Residents & Businesses

Under current federal tax law, the U.S. includes worldwide income of domestic corporations and U.S. citizens and residents in gross income. However, bona fide residents of Puerto Rico can exclude Puerto Rico source income (except amounts received for services performed as an employee of the United States or any agency thereof). There were about 12,700 federal employees in Puerto Rico in 2022. Any income taxes imposed by U.S. possessions and foreign countries are allowed as an offsetting federal income tax credit or a tax deduction. In addition to federal income taxes, Puerto Rico employers and employees are subject to Federal Insurance Contributions Act (Social Security and Medicare), and Federal Unemployment Tax Act (FUTA) on wages, and self-employed Puerto Ricans similarly must pay these taxes on their net earnings.

Recent surveys determined that higher shipping costs add hundreds of millions of dollars a year, equivalent to a 7.2 percent tax in Puerto Rico. Consumer goods including food and beverages are significantly more expensive in Puerto Rico because goods from the states must be transported on U.S.-made, crewed, owned, and flagged vessels under the Jones Act. More recently, the Tax Cut and Jobs Act of 2017 imposes a 12.5 percent tax on profits related to intellectual property exported from foreign countries and Puerto Rico.

In response to the global pandemic, among other financial relief, Congress significantly expanded and enhanced the 2021 CTC. Most families with children qualified for the enhanced CTC of up to $3,600 per qualifying child under 6 and up to $3,000 for qualifying children from age 6 to and including age 17. Congress also made the credit fully refundable ensuring that the most vulnerable children including those whose families have little or no income would receive it. In an effort to get the CTC into households as quickly as possible, Congress required that the Internal Revenue Service (the “Service”) deliver the CTC in advance monthly, beginning in July 2021 and extending through December 2021. The expanded, advanced CTC was quickly and broadly successful reducing childhood poverty by about 40 percent.

For the first time, Congress included all qualifying children in Puerto Rico in the expanded, enhanced 2021 CTC. However, Congress did not direct the Service to pay the 2021 CTC to residents of Puerto Rico in advance, therefore these families had to wait until they filed their 2021 federal income tax return in 2022 to receive any CTC benefits. Because most families in Puerto Rico have never had to file a federal tax return because their income is generally not subject to federal income taxes and they have not qualified for the CTC or other tax benefits like the EITC, the federal government has engaged in significant outreach programs. But not surprisingly, given the lack of experience filing federal tax returns, the participation rate in Puerto Rico has not been as robust as in the states. As a result, not only were CTC benefits delayed until 2022, but fewer families per capita in Puerto Rico received any CTC benefits than in the states.

Prior to the broad-expansion of the CTC in 2021, despite childhood poverty rates exceeding 56 percent, only 11 percent of Puerto Rican families qualified to receive any amount of CTC. This was because prior to the pandemic, only Puerto Rico residents paying into Social Security with three or more qualifying children qualified for CTC benefits. State and Washington D.C. counterparts only had to have one or more qualifying child. Fortunately, the American Rescue Plan Act (ARPA) permanently amends the CTC allowing residents of Puerto Rico to qualify for the CTC with any number of children, even after other pandemic expansions ended after 2021. However, because many Puerto Rican families with children do not have a federal income tax liability the CTC is limited to a maximum benefit of $1,400 (indexed for inflation and $1,600 in 2023) per qualifying child. And the CTC only applies where taxpayers have earned income above the $2,500 threshold amount (at 15 percent of every dollar above the threshold up to the applicable caps).

Since its enactment in 1972, Puerto Rico bona fide residents have not and do not presently qualify for federal antipoverty relief for working families through the EITC. Beginning in 2007 through 2013 Puerto Rico enacted, funded, and implemented a locally administered EITC; however, the credit was significantly smaller than the federal EITC with average annual benefits of only $300. These antipoverty efforts mirror to some extent programs in about 30 states and Washington D.C. that have enacted state EITCs that bolster federal EITC benefits.

As a result of required financial structural reforms implemented by the FOMB, Puerto Rico reintroduced the EITC in 2019. The new maximum EITC increased to $2,000 from $450 in 2013. Approximately 255,000 families claimed the credit, with a final investment by Puerto Rico of $115 million of the $200 million budgeted. The average 2019 EITC was $450; including $258 for households with no children; $456 for households with one child; $851 for households with two children; and $1,102 for households with three or more children. Almost 88 percent of households receiving the Puerto Rico EITC reported income under $20,000.

In its March 2021 pandemic relief bill, Congress committed up to $600 million of EITC funding annually in addition to the $200 million funding budgeted by Puerto Rico. In response to this funding, Puerto Rico EITC benefits for working taxpayers more than tripled effective for 2021 tax returns. The expansion increased the maximum EITC from $1,500 for workers with no children to $6,500 for workers with three or more children, up from previous amounts of $300 and $2,000, respectively. In addition, the expanded EITC covers broader income ranges, self-employed individuals, and 19 year-olds (compared to the prior age limit of 27) and up. Early estimates indicated that the expanded EITC would nearly double the number of qualifying households in Puerto Rico from 255,000 to 466,000 including about 55,000 newly eligible households that would be lifted out of poverty. These targeted benefits should not only provide antipoverty benefits for these households but should also help stimulate the local economy because EITC dollars are typically spent within the communities where recipients live, resulting in exponential economic benefits to city, county, state, and now Commonwealth businesses and governments.

The tax treatment of U.S. corporations operating in Puerto Rico is complicated. Income earned in Puerto Rico by active business operations of U.S. corporations is considered foreign-source income. This income is subject to U.S. income taxes. However, income earned by foreign subsidiaries of U.S. corporations, controlled foreign corporations (CFCs), can be deferred until the foreign-source income is “repatriated” through dividend distributions to the U.S. parent corporation. As a result, most U.S. corporations with active business operations in Puerto Rico are organized as CFCs to benefit from the federal tax deferral.

The following listing is a summary of the major congressional enactments affecting Puerto Rico.