Experts discuss Puerto Rico’s Debt Crisis, Possible U.S. Role

The Brookings Institution held a panel discussion yesterday on the debt crisis in Puerto Rico at which experts spoke on the economic problems facing Puerto Rico and  possible solutions.  As proposals for reform were raised, and often rejected, an underlying theme was that Puerto Rico’s territorial status has given rise to unique problems that are proving difficult to solve.

The panel was composed of three experts: Palmira N. Rios Gonzalez (acting dean of the faculty of social science at the University of Puerto Rico), David Hitchcock (senior director in the state group at Standard & Poor’s Ratings Services), and Barry P. Bosworth (senior fellow in the Economic Studies program at the Brookings Institution). Darrell West, who is the Vice President and Director of Governance Studies for the Brookings Institution, served as moderator.

David Hitchcock of S&P explained that Puerto Rico’s economic situation – specifically the government’s lack of liquidity and limited access to external debt markets – resulted in the downgrade by Standard and Poor’s Rating Agency in February.  Hitchcock noted that the Puerto Rican government has passed a balanced budget for FY15 but expressed concern over “implementation risks.” He further mentioned that pension assets are almost depleted and he expects a significant increase in health care costs that may require tapping into general funds. Hitchcock expects a structural imbalance in the years ahead and added that S&P’s current rating is focused on Puerto Rico’s long term outlook.

In his opening remarks, Barry Bosworth observed that this is not a new problem for Puerto Rico. While fundamental fiscal problems reflect mistakes of the government, he noted that the island’s economy has been in the process of collapsing for over 25 years. Bosworth pointed out that the Puerto Rican population has declined by 6% since 2010 and it is not just highly skilled laborers who are leaving the island. Because Puerto Rico is subject to the federal minimum wage, low skilled workers have better opportunities for minimum wage jobs on the mainland.

Bosworth also focused on the lack of economic proposals for Puerto Rico that actually benefit Puerto Ricans. Proposals for the territory have been focused on the battle between the two investment camps: Hedge funds expecting to make money off of a possible default and others seeking to benefit from possible corrective action. These types of discussions, which are dominating recovery talks, are most beneficial to investors, not Puerto Rican residents.  Noting Puerto Rico’s high poverty rate, Bosworth asked rhetorically what the U.S. should do in light of the fact that Puerto Ricans are U.S. citizens. He concluded that we are obligated to have an answer beyond migration.

Bosworth  discussed Law 22, a Puerto Rican law that eliminates taxes on dividends, interest and capital gains for people who move to the territory as long as they have not lived in Puerto Rico at any point prior to the fifteen years preceding the law’s passage (January 17, 2012).  He called Law 22 an “outrageous proposal” that “normal Puerto Ricans have no access to.” Bosworth further expressed concern that the law could erode sympathy for Puerto Rico among federal policy makers.  He pointed out that the law won’t bring in a lot of revenue but it could change the atmosphere of whether Congress will be willing to help Puerto Rico across the board.  Bosworth added that he “wonder[s] about the future of the tax law.”

Hitchcock stated that no one knows how to grow the economy and went through a litany of industries – tourism, manufacturing with the “Made in USA” label, Law 22 and medical tourism – before concluding that none seem like large areas for advancement now.

Another audience member asked about a pending VAT proposal in Puerto Rico. David Hitchcock responded that we cannot say if the new proposed tax regime will change tax collection and raise the promised $1 billion. Hitchcock said that S&P will look skeptically at the claim that a new VAT will bring in new revenue simply due to increased enforcement. He further emphasized the need for a real justification for the optimism that a new VAT will be effective – not just a line in a budget or “back of the envelope” calculation. Ultimately, S&P will look for new revenue, which, again, he is very skeptical he will see. Hitchcock recanted the numerous strategies proposed over the years to strengthen enforcement of tax collection in Puerto Rico and noted that none have worked.

Rios Gonzalez also questioned whether the current government structure is sufficient to provide for the implementation of this  proposed tax. She expressed doubt that the government had adequate resources to make such a transition successfully.

A professor in the audience noted that when municipalities have faced similar economic situations, they have either resorted to financial control boards or turned to Chapter 9 of the U.S. Bankruptcy Code for restructuring help. He asked if that was possible for Puerto Rico. Rios Gonzalez replied that a number of Puerto Rican agencies are already under control of the federal government, such as the police, environment and special education. Later in the discussion, another individual asked about possible federal intervention such as loan guarantees or other financing methods offered to foreign countries. She expressed frustration that Puerto Rico is hamstrung in a situation it lacks the power to solve on its own (including an inability to act on Jones Act and minimum wage reforms). Bosworth responded that the federal government wants to help; what is lacking is a plan.

Finally, it was discussed that Puerto Rico has not seized on a geographic opportunity to serve as the business gateway connecting North America, South America, and Europe. Its central location and ties to the United States suggest Puerto Rico as the prime location for such a gateway, but its lack of effort has allowed Miami to grow as the connecting gateway for the Americas and Europe. It was noted that Puerto Rico could similarly pursue this opportunity.

In closing, Barry Bosworth suggested that Puerto Rico enact tax reform that dramatically lowers the rates while broadening the base. He conceded that given the low participation in the workforce, it is not nearly sufficient action, but a step in the right direction. Bosworth also noted that biggest issue moving forward is that there are simply no jobs in Puerto Rico.