In a tale of pirates, rum and economic warfare, the US Virgin Islands have lured Captain Morgan maker Diageo from Puerto Rico, leading to a daggers-drawn political battle in Washington.

The story began in 2008 when the Virgin Islands enticed Diageo to locate a new distillery for Captain Morgan rum — named after 17th century privateer Henry Morgan — with tax credits and benefits worth an estimated US$2.7 billion over 30 years.

Diageo, the world’s largest maker of distilled spirits, will get the benefits from a little-known “cover tax” that is collected on all rum sold in the United States and returned to rum-producing US territories in the Caribbean for economic development and welfare.

A dastardly scheme, say Puerto Rico backers, who have been battling for months to block the deal, arguing that taxpayer funds are being diverted to a non-US company.

“Congress need only look in their liquor cabinets to see Captain Morgan Rum and its British owners staging the biggest pillage of US tax dollars since the days of piracy on the high seas,” said Miguel Lausell, chair of the National Puerto Rican Coalition.

“Congress must scuttle Captain Morgan’s raid on American tax dollars and its plunder of domestic distillery jobs.”

The group has backed legislation introduced by the non-voting congressional delegate from Puerto Rico, Pedro Pierluisi, to make it more difficult for the Virgin Islands to offer the subsidies with cover-tax revenues.

But Diageo and the Virgin Islands have fired volleys to Washington to encourage Congress to stay out of the fight between the two US territories, arguing that Diageo was already planning to end its contract production in Puerto Rico for a location outside the United States.

The proposed legislation “undermines the intent of the Congress when they designed the program for the territories,” said Donna Christensen, the US Virgin Islands (USVI) delegate in Congress.

She said a study by the Congressional Research Service concluded that the bill “would result in severe limits on Puerto Rico’s and the USVI’s ability to finance economic development projects with this revenue source.”

Diageo North America vice president Guy Smith last month fired his own broadside, claiming the real villain is rival Bacardi, a Bermuda-based company trying to protect its own subsidies.

Smith said Bacardi “has been working behind the scenes in collaboration with other self-interested constituents and corporations and has used front groups and Puerto Rico politicians to make spurious claims about the US Virgin Islands initiative.”

Bacardi spokeswoman Patricia Neal said the issue is “about the proper use of federal tax dollars. Diageo has some explaining to do to the US Congress and American people.”

Captain Morgan has been produced in Puerto Rico for more than 20 years and Dieago acquired the brand in 2000 from the sale of Canadian firm Seagram.

It has been looking for a location for its own distillery since its production contract with the Puerto Rico-based Serralles distillery expires in 2011.

US Virgin Islands Governor John deJongh said that Puerto Rico might get an advantage by driving Diageo outside the United States because of the way the cover tax is structured.

DeJongh said congressional meddling “could cause us to default on hundreds of millions of dollars in bonds,” and “would force the government of the US Virgin Islands to the brink of receivership.”

This, in other words, means economic war for the two US possessions.

“Puerto Rico has not only given up any pretense of negotiating their concerns with the US Virgin Islands,” the governor said, and “now also seems willing to walk away from the long history of friendship and collaboration which has linked America’s two Caribbean possessions.”

At the nonpartisan watchdog Tax Foundation, economist Kail Padgitt says both sides are wrong to use the tax funds to subsidize producers.

“The excise tax on alcohol is most often justified as a moral argument against the personal ills of overconsumption…. This logic breaks down when the taxes go back into subsidizing the same product,” he said.

“It seems as if Puerto Rico and the Virgin Islands have taken a lesson from Captain Morgan’s book and decided to raid the taxpayers’ wallets.”