This story was printed in Politico on Oct. 26, 2008

As Congress debated the historic financial rescue package on Oct. 3, the world economy was hanging in the balance. The House already had rejected Treasury Secretary Henry Paulson’s emergency $700 billion banking bailout plan. The Senate, hoping to get the House to relent, added $110 billion in “sweeteners” and sent the bill back.

One of those sweeteners jumped out at Rep. Marcy Kaptur (D-Ohio). It would permit Puerto Rico and the U.S. Virgin Islands to pocket $192 million in federal excise taxes collected from rum-makers in those territories.

“Madam speaker, the Senate's response to the House rejection of the Paulson plan was to add more spending. So we got tax breaks for rum,” Kaptur said from the well of the House. “You've got it right. R-U-M.”

Lobbyists for Bacardi and Captain Morgan, the two most popular rum brands in America, howled in protest at the suggestion the money would go to rum-makers. The provision does not give money to Bacardi and Captain Morgan, they said. It gives it to Puerto Rico and the Virgin Islands to build up their economies in hopes of averting the need for larger financial handouts from the mainland, they argued.

Once the rescue bill was signed into law, the rum provision was quickly forgotten. If it hadn’t been attached to the controversial bank bailout bill, Congress probably would have extended it with little or no dissent, as it does routinely every couple of years.

“I'm sure that the members of Congress who were yelling about a tax break for rum distillers have probably voted for it as long as they've been in the Congress," said Frank Coleman, spokesman for the Distilled Spirits Council, a trade association that represents the liquor industry in Washington.

But the momentary furor over the provision at a moment of high political drama focused rare attention on the 91-year-old tax provision. And when ProPublica looked closer, it found that a significant share of the $192 million will indeed go to rum-makers as marketing subsidies and production incentives.

What’s more, that $192 million is just part of a larger pot of rum excise tax money Congress steers to the territories each year under what is known as the rum “cover over” program. Rum-makers get a significant chunk of the larger pot, too.

Currently, their share amounts to tens of millions of dollars each year. But that could grow many-fold, because rum-makers are now playing the two U.S. territories against one another to grab a far larger share of the federal excise taxes.

In 2012, Diageo, the parent company of Captain Morgan, will move its operation from Puerto Rico to the Virgin Islands in exchange for more of the excise tax money. Puerto Rico has been giving Diageo a small fraction of its excise tax revenue. The Virgin Islands will give Diageo close to half of its share.

Diageo said that without that lucrative deal, it would have left the U.S. territories for a country where it could operate more cheaply, and the Virgin Islands would have ended up with nothing. This way, the company argues, it is keeping jobs in the U.S. territories.

But critics say the Virgin Islands is setting a bad precedent by being so generous to the world’s largest liquor company, which is based in London and had $4.2 billion in operating profits last year.

"To give the people's money away to a foreign company replete with cash and equity is mind-boggling," said Virgin Islands territorial Sen. Neville James. "There is economic development and then there's giving away the ranch. These flat giveaways of excise tax rebates create a cause for concern.”

For decades, Congress has been giving Puerto Rico and the Virgin Islands most of the excise taxes the islands’ rum-makers pay for each proof gallon of rum they sell within the United States. Puerto Rico, which has four rum-makers, gets about $400 million a year. The Virgin Islands, which has one, gets about $80 million. The federal government keeps about $9 million.

Tension between the territories surfaced in June, when Diageo and the Virgin Islands stunned Puerto Rico by announcing that the Captain Morgan brand would move from Puerto Rico to the Virgin Islands in 2012.

Captain Morgan is the second-most-popular rum in the United States and its market share is rapidly increasing. Shifting production to the Virgin Islands will shift a large amount of the rum excise tax revenue there, too. That’s because the amount of money each territory gets is proportional to the amount of rum produced there and sold in the United States.

Under the deal, the Virgin Islands is to build Diageo a $165 million, state-of-the-art plant on the island of St. Croix. After assuming a $500 million debt obligation associated with the plant’s construction, the Virgin Islands will hand over the keys and title to Diageo. The Virgin Islands will tap its portion of the rum tax revenue to pay the $18.4 million in annual financing costs.

The 30-year agreement also gives Diageo a $2.1 billion marketing subsidy, a 90 percent break in its income taxes and a complete exemption from property taxes. With other benefits under the agreement, including a molasses subsidy, Diageo can get up to 46 percent of the Virgin Island’s excise tax revenue each year.

Last year, Diageo had $15 billion in net sales thanks to its vast stable of popular liquor brands, including Dom Perignon, Smirnoff, Tanqueray, Jose Cuervo and Guinness.

By contrast, the Virgin Islands government’s entire budget for the coming year is $842 million.

"When you realize that money instead of going to do domestic development in the U.S. Virgin Islands or in Puerto Rico actually ends up lining the pockets of the largest liquor company in the world, you have to question whether this is a good deal at all,” said Steve Ellis of Taxpayers for Common Sense, a group that combats wasteful government spending. “We’re essentially financing Captain Morgan."

While Captain Morgan’s move will be a boon for the Virgin Islands and Diageo, it will come at a great cost to Puerto Rico, according to some industry analysts, who estimate its direct and indirect losses could be $6 billion over 30 years.

Workers at the Puerto Rican distillery Serralles, which has been making rum in Ponce since 1865, will be the first to feel the sting of the move.

Peter DeMay, director of organizing for the union that represents the Serralles workers, Unite Here Local 601, said that when Captain Morgan production ends there, 160 jobs that pay $14 to $16 an hour and offer family health care, sick days and pensions will be lost.

The contract between the Virgin Islands and Diageo calls for just 40 jobs at the new plant on St. Croix, and DeMay said those workers will be protected only by the federal minimum wage and territorial labor laws.

“The deal that they have with the Virgin Islands is a sad commentary on the economies of both islands and how taxpayer money is consistently used to subsidize some of the richest corporations in the world,” DeMay said. “It's sad that there's a system where our tax money goes to fund a race to the bottom.”

Virgin Islands Gov. John P. deJongh Jr. defended the deal.

“When fully built out and operating, the Diageo rum facility will enable us to address our long-term challenges, in particular our unfunded pension liability and long-needed capital projects, without having to take the money from other areas of need, or borrow from our *****ren,” deJongh said.

Diageo, in a written response to questions from ProPublica, said its distillery would help the Virgin Islands “become economically self-sufficient as it moves from historic budgetary deficit to budgetary surplus.”

Diageo had already decided to leave Puerto Rico, probably for somewhere in Central or South America, when it approached the Virgin Islands about a year and a half ago about relocating there, said David Paul, a financial adviser to the government of the Virgin Islands. At least the deal struck with the Virgin Islands kept Diageo from leaving the United States altogether, Paul said.

The agreement between Diageo and the Virgin Islands will greatly increase the excise tax revenue that circles back to the liquor conglomerate. Diageo will pay the rum excise tax to the U.S. Treasury. The Treasury then will forward most of it to the Virgin Islands. And the Virgin Islands will give close to half of what it gets back to Diageo.

That subsidy circle raises a question: With the nation facing a financial crisis, does it make sense to continue giving the two territories $480 million a year, especially if an increasingly large chunk of that money goes back to the rum-makers?

The rum “cover over” program began in 1917, when the U.S. government decided to tax Puerto Rican rum-makers on rum sold within the United States. After the money was collected, most of it was passed along to Puerto Rico for economic development and infrastructure needs.

In 1954, the same benefit was extended to the Virgin Islands.

The rum excise tax was set at $13.50 per proof gallon. Historically, the government has passed along $10.50 per gallon to the two territories. In 1991, the government began passing along even more — $13.25 per gallon — but that extra $2.75 must be approved periodically by Congress. It has done so without fail, most recently through the bailout legislation.

Puerto Rico, the self-proclaimed Rum Capital of the World, currently sets aside $25 million of the $400 million it gets in excise tax money each year to fund the its rum-marketing arm, Rums of Puerto Rico. Rums of Puerto Rico then passes along about $15 million to the island’s rum-makers in the form of marketing subsidies and production incentives, according to Karen Garnik, director of Rums of Puerto Rico.

The Virgin Islands last year gave its sole rum-maker, Cruzan, $5 million of its $80 million in excise tax money. It also gave Cruzan a $15 million molasses subsidy from its general fund. In future years, Cruzan can boost its share of the excise tax money by increasing its sales within the United States, said Paul, the Virgin Islands’ financial adviser.

The new agreement between Captain Morgan and the Virgin Islands could be a game changer in terms of how the territories use their excise tax revenue, said Jaime Gonzalez, a senior policy adviser to Del. Luis G. Fortuno, Puerto Rico’s nonvoting delegate to the U.S. House.

For one thing, it pressures Puerto Rico to strike a similar deal with Bacardi, its top rum-maker and the most popular brand in the United States, or risk seeing Bacardi move to the Virgin Islands for a better deal.

"Bacardi can turn around and tell the government of Puerto Rico, 'Hey, the Virgin Islands is willing to give me back 50 percent of what we generate. I want you to give me 50 percent or if not I'll go to the Virgin Islands,’” Gonzalez said. “There's nothing to hold them back. Basically, it's blackmail.”

Gonzalez worries that the Virgin Islands’ generous deal with Diageo might jeopardize congressional support for the 91-year-old rum “cover over” program.

"My true concern is that Congress will find that those kinds of incentives are too rich, especially for a foreign company, based on the number of jobs it's going to create, and that it will endanger the attitude of Congress on all of the cover over tax return,” he said. “Congress is going to take a very close look at the incentives in light of this whole financial rescue plan."

ProPublica Director of Research Lisa Schwartz contributed to this report.