The billion dollar war behind U.S. rum

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0:26This is St. Croix. In the U.S. Virgin Islands. It's a Caribbean paradise. Pink and cream-colored buildings, boosters are everywhere. There's a harbor dotted with yachts and catamarans. On boardwalk, people are having drinks and watching the seaplanes take off. The economy here mainly runs on tourism. But our trip took us away from the beach and the palm trees because we were here for something else. Ooh, this street is bumpy. You see, these days, there is only one major product that the Virgin Islands produces. Rum. And lots of it. That is what we were here for, the rum. Oh my gosh, is that it?

1:11Holy, that's huge. In particular, producer James Sneed and I are here for one of the biggest rum distilleries in the world. We could see it on the horizon, rising out of the lush countryside, looking huge and out of place. Let's pull up next to the sign. The sign says, got a little captain in you. Question mark. You know, Captain as in Captain Morgan, the rum with the pirate and the red coat who's got his leg propped up on a barrel. Ah, yes. The drink of my youth. I know it well. Sarah, you should have come with us. My Captain Morgan days are long, long over, Jeff. Now, the Captain Morgan people wouldn't let us into the distillery, but we did try to peek in through the barbed wire fence.

1:57If I saw this, I would assume that they were like manufacturing something way more serious. Yeah, like fertilizer or like oil or something. Yeah, it looks like an oil refinery. A quarter of the rum that Americans drink is Captain Morgan rum. And all of it comes from this one mega distillery on St. Croix. Oh, look, there's someone in a... Yeah, hi. They're in a hard hat and... Oh, he gave us a thumbs up. Nice. We came to see this distillery because this was once the center of a vicious economic battle. You see, Captain Morgan didn't always come from St. Croix. For many years, Captain Morgan rum was actually made in a different place, in another U.S.

2:39territory, in Puerto Rico. Yeah. But in 2008, the government of the Virgin Islands made a secret plan to lure Captain Morgan away from Puerto Rico and bring it to the Virgin Islands. Those were the rum wars. No, the competition has changed. This was the beginning of the rum wars. Hello and welcome to Planet Money. I'm Jeff Kuo. And I'm Sarah Gonzalez. The rum wars between the Virgin Islands and Puerto Rico go back to this peculiar thing that Congress came up with over 100 years ago. A scheme that was supposed to help these two U.S. territories pay their bills. Today on the show, how that scheme wound up giving big liquor companies hundreds of millions in U.S.

3:27taxpayer dollars. And how it turned these two territories into bitter rivals, competing to make as much rum as they can at almost any cost.

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4:24Capital One. What's in your wallet? Terms apply. Details at CapitalOne.com. There are many things to love about St. Croix. The rum. Our rum, from a quality standpoint, is the best in the world. How small it is. Everybody knows everybody. You know what I'm saying? The local music. Quilbe music, which is like scratch band. This is Neville James. His family has been here for generations. We're a hard day's work for a hard day's pay. That's the mentality I'd say, good, right? Neville used to host a Saturday morning radio talk show. It was called Gimme the Word. Gimme the Word. Like, how would you introduce yourself on the air?

5:03It was a crazy week in paradise, and we're going to break it down for you. You know what I'm saying? It's amazing. Neville gave up his radio job to go into politics. He was actually a local senator on the island at a very important time back in 2008 when the Virgin Islands and Puerto Rico first got wrapped up in the rum wars. I tell you, man, this thing made enemies for us, man. The thing the Virgin Islands and Puerto Rico were fighting over has to do with this special funding arrangement that the two territories have. Territories are part of the U.S. People in the Virgin Islands and Puerto Rico are American citizens, but they don't have all the same rights.

5:43And historically, Congress didn't want its territories to be too dependent on the federal government. So it would look for ways to provide them with their own funding stream. And for Puerto Rico and the Virgin Islands, rum plays a big role. Now, if you have ever bought a bottle of liquor anywhere in the 50 states, you probably paid a bunch of taxes on it. Local tax, state tax, federal tax. The federal tax on hard liquor usually comes out to like$2 for a normal sized bottle. And that money goes straight to the U.S. Treasury, where the government spends it on, you know, government-y stuff. Yeah, unless you are talking about one particular kind of liquor, rum.

6:24When you buy a bottle of rum in the U.S., the federal taxes collected on that bottle do not all stay in the United States and in the Treasury. Instead, most of the tax money gets sent to either the Virgin Islands or Puerto Rico, whoever made the rum in that bottle. So if the rum was made in Puerto Rico, Puerto Rico gets the taxes. If the rum was made in the Virgin Islands, the Virgin Islands gets the taxes. And actually, and this part blew my mind, even if the rum was made in another country, like in Barbados, which is another big producer of rum, the taxes still go to Puerto Rico and the Virgin Islands.

7:01They split it. That's the way Congress set it up. What a deal. Only two islands got this sweetheart deal. Puerto Rico and the U.S. Virgin Islands. Yeah, the more rum they make, the more tax dollars they get. And it's a decent amount of money. Recently, the federal government paid the two territories more than$700 million in rum money. Now, Puerto Rico and the Virgin Islands, they're like next-door neighbors. In the summertime, when it gets real clear, you can see Puerto Rico from the farthest point on St. Croix. They are separated by just 40 miles of teal blue Caribbean ocean. But they're pretty different places.

7:41The Virgin Islands is tiny. It's got like 90 ,000 people. Puerto Rico's got 3 million people. And it's just like a much bigger economy. And Puerto Rico's rum industry, also much bigger. They're one of the biggest rum makers in the world. So they get a way bigger share of that federal rum tax money. Historically, they got like five times what the Virgin Islands would get. Yeah. But in 2008, Neville says the Virgin Islands made a big play for Puerto Rico's big pot of rum money. The governor told us he got a big deal coming. And we were like, oh, really? Because we were looking for any kind of deal.

8:19Neville had been serving in the Virgin Islands legislature for a few years at this point. And the Virgin Islands was having a hard time. They were in an energy crisis. There weren't enough jobs because most big companies didn't want to take a chance on this territory of tiny islands. But in June of 2008, the governor announced that Captain Morgan, the second biggest rum brand in Puerto Rico, was considering leaving Puerto Rico behind and coming next door to the Virgin Islands. The plan was to build this big$165 million distillery right in the middle of St. Croix. Neville is hearing this and he's like, whoa, this could totally turn things around for us.

8:59We were going to be a player. You know, that was big. The governor calls a special session of the Virgin Islands legislature so they can all vote on the deal he's negotiated with the liquor company. As a senator, Neville is going to have to decide yes or no. So he's like, OK, I'm going to analyze this thing inside and out. Everybody has their niche, right? So mine was history and numbers. breaking on the numbers. I'm not saying I'm the best at it, but I enjoy doing it. So I got labeled as the numbers cruncher. When the proposal lands on Neville, the number cruncher's desk a few days later, it's long, 40 pages.

9:36And in these pages, Neville starts to see things that kind of make him go like, hold on here. It looks like there are these giveaways to Captain Morgan. Like if this deal goes through, the Virgin Islands would subsidize molasses, the main ingredient in rum. It would help pay for Captain Morgan's marketing budget. It would give them these production incentive bonus things. Altogether, the government would be handing over almost$80 million a year to Captain Morgan once everything was up and running. Yeah. And you know that brand new distillery that Captain Morgan was going to put in the middle of St.

10:10Croix? Neville sees that Captain Morgan wouldn't actually be the one paying for that. that the Virgin Islands would actually be the ones picking up the entire$165 million bill. And the only way the deal made any financial sense at all for the Virgin Islands was because of that federal rum tax program. The federal taxes we pay when we all buy a bottle of rum. Right. Because of the way that program works, every gallon of rum that the new Captain Morgan distillery would produce would mean more of that rum tax money for the Virgin Islands government. Yeah, and under the proposal, the Virgin Islands was going to funnel a lot of that rum tax money straight to Captain Morgan, like 40 percent of the money.

10:53The Virgin Islands would get the rest and they would actually still come out ahead by like$100 million a year. So Neville's wrapping his head around those numbers. And then he notices this other thing, this whole deal with Captain Morgan. It's not actually with Captain Morgan. I thought Captain Morgan was Captain Morgan. I didn't know Captain Morgan was a brand that was owned by Diageo. Yeah, Diageo is one of the biggest liquor companies in the world, headquartered in London. And they don't just own Captain Morgan, they also own Smirnoff, Johnny Walker, Guinness. That's when I started doing my research about Diageo and who they're about and all that stuff.

11:38Neville finds out that Diageo had been making Captain Morgan rum in Puerto Rico for years, but their contract with the distillery was ending, so they started to look around to see what their options were. That's how this whole deal started in the first place. The Diageo folk realized that they could play the Virgin Islands against Puerto Rico and against each other, you know what I'm saying? Yeah, Neville is not so sure about this deal anymore. He's starting to see it as just a way for this giant$50 billion company to muscle in and take a cut of that federal rum tax money, money that only the Virgin Islands and Puerto Rico have access to.

12:14Our economy is a$4 to$5 billion economy. Why are we making all these amenities available for somebody who's 10 times financially more valuable than we are as a jurisdiction? There's something wrong with that. That's too much money, man. That's giving away public money, man. A couple weeks after the governor's big 2008 announcement about this possible deal, the legislature has a special two-day session to vote on in. That was one of the highest profile sessions in the history of the Virgin Islands. There are crowds of people outside, TV cameras rolling. All these bigwigs from Diageo have flown in from London to testify, to persuade Neville and the other senators to approve the deal.

12:55White guys in suits, you know what I'm saying? They look like Madison Avenue. These guys are sharks, man. They're trying to make money. Yeah, and Neville and some of the other senators, they want to show these guys that, like, they can hold their own. Everybody's trying to sound Harvard, Yale-like, you know what I'm saying? You know, we're speaking that Yankee twang, you know. We're letting them know, you know, we may be small, but we are loaded with quality. One by one, the senators get their turn to speak and ask questions. Most of the senators, they are for this deal. They know Diageo is driving a hard bargain, but they're saying, look, the Virgin Islands is a tiny, struggling economy.

13:35We got to take what we can get. There are a few senators on Neville's side. They don't love the idea of giving so much money away to a big liquor company. But they're also worried about how Puerto Rico will react to all of this, you know, Because stealing Captain Morgan isn't just going to cost Puerto Rico jobs. It's also taking a whole lot of that federal rum tax money out of Puerto Rico's pocket. And Neville is kind of like, I don't know, I think this is going to start something. Poaching is a very dangerous practice because who's to say that Puerto Rico wouldn't do that to us? We don't want to get in a competition with him.

14:14Neville's like, Puerto Rico can play this game too. And if they start giving away a lot of money to rum companies, where is this all going to end? Neville is worried that this could be the beginning of a classic race to the bottom. So when it's Neville's turn to talk, he pulls out three pages of a handwritten speech. He unfolds it and starts to read. He says, I know the Virgin Islands is in a tough spot. I know we need this money. But giving away so much, that could really hurt us in the long run. The thought of giving away the people's money to a foreign company replete with cash. I repeat, a foreign company replete with cash and equity is mind boggling.

14:55And then Neville challenges his fellow senators. He says, say no to this deal. Force the governor and Diageo to go back to the table and come up with something better for the people of the Virgin Islands. And this speech, it does not go over that well. Everyone on the island is following these hearings, right? And before the vote, Neville is like flooded with calls from neighbors, cousins, his friends, his dad's friends. And most of them are saying things like, whose side are you on, Neville? Oh, you sided with Puerto Rico against the Virgin Islands. My counter argument is, no, I want your mother and your sister and your wife to keep that money instead of that money going back to people who already got money.

15:37In the end, 10 out of the 15 senators vote to approve the Captain Morgan deal. And Neville's like, all right, buckle up for some drama. Now the competition has changed, right? Both of you had your lane, so to speak. Now it's no more lane. We're crossing over. We're enemies now. For years and years, Puerto Rico was producing their rum, the Virgin Islands was producing theirs, and they were both getting their cut of the federal rum tax money. Neville's thinking, from here on out, it is not going to be that easy. And it wasn't. Because when people in Puerto Rico learned that the Virgin Islands had successfully stolen one of their major rum companies, they were not happy.

16:22When that happened, it was a complete shockwave on the island because losing that industry would be catastrophic. After the break, Puerto Rico makes a plan to get even.

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18:00Capital One. What's in your wallet? Terms apply. Details at CapitalOne.com. When Puerto Rico found out about the deal the U.S. Virgin Islands made with Captain Morgan, there was a sense of danger. Like, they were suddenly at the edge of a precipice. Because rum is a big part of Puerto Rico's economy and its culture. Puerto Rico is the rum capital of the world. Jennifer Gonzalez-Colon is Puerto Rico's representative in Congress. You talk about Tennessee, you would think about whiskey. You talk about California, you would think about wine. You think about Puerto Rico, it's going to be rum. Jennifer used to serve in Puerto Rico's legislature.

18:37She actually became House Speaker around the time of the Captain Morgan deal. And she says that there was almost a sense of like panic at that time. We just lost Captain Morgan. Is Bacardi doing the same thing and is moving to Virgin Islands or any other jurisdiction? And what happens if we lose Bacardi? Bacardi was Puerto Rico's top rum maker. The Bacardi distillery was like the crown jewel of Puerto Rico's rum industry. Helped them claim a big slice of that federal rum tax money. And Puerto Rico did spend some of that money to subsidize its rum industry, but only like 10 percent. What the Virgin Islands was doing with this Captain Morgan deal was taking 40 percent of that rum tax money and giving it straight to this big liquor company.

19:21And Jennifer was like, this is this is a dangerous precedent. If you open the door to one company to take that money, that means that other companies can ask or do the same kind of deals. Right. Puerto Rico was worried about the same thing Neville was worried about, that they in the Virgin Islands were about to be forced into this downward spiral where companies would keep playing them off each other to get more and more generous tax breaks and subsidies until there wasn't much of that federal rum tax money left for the territories. Now, there is a solution to this game of escalating subsidies, which is to just blow up the game entirely.

19:59And that is what politicians in Puerto Rico tried to do. They went to Congress and said, you created this program. You can put some better rules around it so that all of this federal money doesn't end up in the pockets of big foreign liquor companies. We tried to say that the money was not a good investment of the federal funding because you were just making rich one company to make business. This turned into a huge fight on Capitol Hill. Now, territories don't get a vote in Congress, but the Virgin Islands, Puerto Rico, Diageo, they all had people in D.C. making their case. Diageo accused Puerto Rico of trying to, quote, destroy the economy of the U.S.

20:38Virgin Islands. The territories each spent almost a million dollars on lobbyists. There's a whole thing. That was when people started calling it the rum wars. Yeah, but then Congress stepped in to do what it is best at doing, which is nothing. They did nothing. So Puerto Rico could not actually blow up the game. So the next thing that Jennifer and her fellow politicians tried to do was resist. See if they could hold the line on subsidies to rum companies. The government of Puerto Rico was trying to meet directly with those companies, trying to let them stay on the island. But it was impossible to fight with a good offer from the Virgin Islands.

21:18Yeah, the companies were saying, without getting those subsidies too, how are we going to compete? By 2011, three years after the Virgin Islands gave Captain Morgan that generous deal, politicians in Puerto Rico couldn't hold the line anymore. They voted to increase subsidies for all of their remaining rum companies from around 10 percent all the way up to 46 percent. So, yeah, the thing that Neville feared that led him to vote against the deal, it happened. The subsidies the Virgin Islands gave to Captain Morgan spread to Puerto Rico's rum industry. And then the subsidies spread right back to the Virgin Islands, costing their government money, too.

21:59because on the Virgin Islands, there was this one rum company that had been there all along. That company was Crujan Rum. In 2012, Neville says, Crujan comes to the Virgin Islands legislature and they're like, hey, all of these other rum companies in the Virgin Islands and Puerto Rico are getting these huge subsidies now. We can't compete with that either. We are losing market share. So Crujan Rum was in trouble. So because of that, we had to go back to the table now and give Cruiser and Rum a similar deal. This is how big rum subsidies became the new normal. And for the Virgin Islands, the new normal is better.

22:40They didn't quite get everything they were expecting, but they did come out ahead by tens of millions of dollars a year. But the real, real winners are the rum companies. Yeah, it used to be that when you went to a liquor store in the U.S. and bought a bottle of rum, federal taxes were basically divvied up between the Virgin Islands and Puerto Rico. Ever since the rum wars, those taxes get divided between the Virgin Islands, Puerto Rico, and a bunch of rum companies. In recent years, those subsidies added up to almost$300 million a year. Do you feel like you've been proven right? Oh, yeah. A long time ago.

23:18A long time ago. But I don't really necessarily want to be right. You know, I want the people to get paid. You know what I'm saying? That's what I want. I want the state to get paid. The Rum Wars have mostly died down by now. But there is one more twist to this story. You know, the thing at the center of the rum wars, the federal rum tax program, it's not actually like a permanent set in stone program. Part of it has to get renewed every couple of years. But in 2021, Congress kind of forgot about it. Just like in the rum wars, Congress did nothing. They did not renew it. And it seems like there's no real reason for Congress not doing anything.

24:00It's just that the territories are not a top priority. They never really have been. So like when you go to the store to buy a bottle of rum in the United States today, a lot less of the tax money goes to Puerto Rico and the Virgin Islands now. And for people in the Virgin Islands, that missing money is a huge problem. If Congress doesn't restore all of that rum tax money soon, this territory of little islands will be in serious crisis. And this time they don't have a secret trick up their sleeve.

24:35Coming up on Planet Money, for a long time, steel manufacturing was one of the biggest sectors in the economy. And when the steel industry in the U.S. started to decline, one small company had a plan to transform it. Ken gets out a rather large cocktail napkin and he's drawing this mill of the future to make sheet steels. And I said, wow, that's a bold ambition. What did you think? Like, what was your thought when he said that to you? You know, no mini mill had ever made sheet steel before anywhere in the world. What the fall of a once great industry can teach us about innovation and why you shouldn't undermine an underdog.

25:15That's out next Wednesday. Drop us a line at Planet Money on social media and planetmoneyatnpr.org.