I get a lot of liquor press releases every day. Usually they’re about new products or horrible, horrible cocktails designed for marketing efforts. Today’s batch includes a release that’s all about trade and taxes:

MERCEDITA, Puerto Rico–Destilería Serrallés released the following statement from Roberto Serralles, Vice President, in response to a 13-page invective issued by Diageo yesterday claiming a conspiracy to “kill” the Captain Morgan Rum production deal between Diageo/U.S.V.I.

“Destilería Serrallés has consistently highlighted the dangers of permitting that unreasonable and excessive rum subsidies be given to any corporation. Our main focus has been, and continues to be, for Congress to hold hearings and to study the merits of HR 2122. This legislation seeks to responsibly regulate the rum cover-over program by placing an-across-the-board 10% cap on subsidies to the rum industry. This is exactly how Puerto Rico has self-regulated itself for over 40 years. All we are asking is that the playing field is kept level, that fair competition prevails, and quite simply, that everyone plays by the same rules,” said Roberto Serralles, on behalf of Destilería Serrallés. “Assertions to the contrary are just delusional conspiracy theories.”

This is the latest salvo in a long-running battle between industry giants Bacardi and Diageo and by extension Puerto Rico and the US Virgin Islands. Understanding the conflict requires delving into some bizarre aspects of the tax code, so let’s break it down. (And if you want to read Diageo’s lengthy statement, click here.)

For background, there are three main spirits industry players involved in this dispute. Destilería Serrallés is a Puerto Rican distillery owned by Bermuda-based Bacardi and best known for its DonQ rum line. Diageo is a British-based spirits company whose many brands include Captain Morgan spiced rum. Diageo contracts with Serrallés to distill the base spirit for Captain Morgan. The contract expires at the end of 2011 and Diageo announced three years in advance that it would not renew the contract. [Correction 2/25/10: Serrallés is independent, not owned by Bacardi. Bacardi's involvement is alleged by Diageo.]

Virgin Islands Governor John deJongh, Jr. successfully courted Diageo to open its own distillery on St. Croix. Among the incentives offered by the USVI are a brand new distillery funded by public bonds and marketing money to promote Captain Morgan; in exchange, Diageo promises to stay in the territory for 30 years and hire local workers. The Wall Street Journal places the value of these subsidies at $2.7 billion over the 30-year deal.

So far this sounds like fairly standard competition between jurisdictions to offer sweetheart deals to corporations, but it gets more complicated. At issue is a strange US tax provision called the rum cover over. This law requires that most of the rum excise taxes collected in the US be remitted to the governments of US rum-producing territories. They receive the funds in proportion to how much rum they produce. Importantly, it doesn’t matter what countries the taxed rum comes from. If you buy Puerto Rican rum, the revenue goes back to US territories. If you buy Jamaican rum, the tax money still goes to US territories. Territories benefit no matter where rum sold in the United States originates.

This is what has created such perverse competition between Puerto Rico and the Virgin Islands. Puerto Rico knows it’s not going to be distilling Captain Morgan much longer, but where Captain Morgan ends up is of huge importance to Puerto Rico. If Captain Morgan goes to a foreign country PR will still reap the benefits of the rum cover over. But if Captain Morgan goes to the Virgin Islands, USVI will become a proportionally larger distiller and get a correspondingly greater share of excise tax revenues; this is the money USVI is counting on to pay back the public bonds it issued for Diageo.

According to the Miami Herald, the loss to Puerto Rico could be as high as $6 billion over three decades. Thus the territory has enlisted legislators to block the Virgin Islands deal, resulting in a heated battle between the territories and the liquor giants.

It’s hard to put any of the parties involved on a pedestal. Serrallés itself receives significant subsidies from the rum cover over program, about 6% of Puerto Rico’s take (again according to the Herald). Nor is it really fair for Puerto Rico to begrudge the Virgin Islands greater allocation of excise tax revenues, given that the alternative is Puerto Rico taking lots of money for rum it doesn’t even produce if Diageo moves to a foreign country.

The real problem is our insane tax code that sends revenue to territories for rum they may not produce and with no strings attached. Thanks to the rum cover over provision, US taxpayers may soon be funneling their money through the Virgin Islands government directly to Diageo. If you’re Diageo you call that a “historic and innovative public-private initiative.” If you’re a libertarian you call it corporate welfare.

My inclination is to side with Bacardi/Serrallés on this one and support a 10% cap on rum subsidies. Or better yet, we could eliminate rum subsidies entirely, a proposition neither Bacardi nor Diageo is likely to support.