A rapid elimination of tax breaks that have fueled growth in Puerto Rico for 20 years could have a disastrous impact on the island's economy, say bankers here.

They predict that as much as 25% of the estimated $28 billion in bank deposits in Puerto Rico could be moved elsewhere if the tax exemptions under section 936 of the Internal Revenue Service Code are eliminated.

They add that the elimination of the exemptions could also hit the island's economy hard. Roughly 40% of Puerto Rico's $27 billion gross domestic product and 100,000 of one million jobs are generated by corporations that take advantage of section 936.

"You can't assume that all companies or deposits would leave, but we would certainly take a big hit," says Arturo L. Carrion, executive vice president of the Association of Puerto Rican Banks.

Introduced in 1976, section 936 allows mainland-based American companies to take a 100% tax credit on any profits earned from doing business in a U.S. possession or commonwealth.

Proposals to eliminate 936 have been raised in Congress since the early 1980s but have been repeatedly postponed. The latest effort has also floundered amid the budget battles between Congress and President Clinton.

Bankers note that although larger banks will be able to find alternative, higher-cost funding, small local banks could experience severe difficulties.

They say that if the tax break has to be eliminated, it should be phased-out over at least 10 years in order to avoid a disruption in Puerto Rico's financial markets.

Meanwhile, the ongoing uncertainty over whether 936 will be eliminated is wreaking havoc with business planning.

"What most people are asking for is a bit more clarity so they can adjust their business plans," says Robert Davila, managing director and senior country officer for Chase Manhattan Corp. in Puerto Rico.

Jorge A. Junquera, senior executive vice president and head of finance at Banco Popular de Puerto Rico, the island's biggest bank, agreed. "What we're saying is: Tell us what the rules of the game are going to be and give us time to adjust," he said. "Puerto Rico is not going to run out of cash, but we are going to have to pay for it at a higher rate."

The banker noted that the cost of funds in Puerto Rico, because of 936, is only 85% of the London interbank offered rate. "That means you're able to finance at lower than market cost," Mr. Junquera said.

Any increase in those rates, he added, "is going to get spread through the entire system, including commercial and personal loans and credit cards."

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