Editor’s note: The next president is in for a rough welcome to the Oval Office given the list of immediate crises and slow-burning policy challenges, both foreign and domestic. What should Washington do? Why should the average American care? We’ve set out to clearly define US strategic interests and provide actionable policy solutions to help the new administration build a 2017 agenda that strengthens American leadership abroad while bolstering prosperity at home.
What to Do: Policy Recommendations for 2017 is an ongoing project from AEI. Click here for access to the complete series, which addresses a wide range of issues from rebuilding America’s military to higher education reform to helping people find work.
After weeks of coverage of Cabinet picks and the presidential transition, are you tired of hearing about Washington politics?
Turn your attention to Puerto Rico, where a severely depressed economy and a bankrupt government has left residents mired in unemployment and poverty. In comes Sen. Marco Rubio, R-Fla., with a policy idea to help Puerto Ricans earn their own success while experimenting with a new program that, if successful, could eventually help encourage work on the mainland as well.
Puerto Rico’s debt of $72 billion has required an aggressive restructuring effort from Congress. More important, the economic problems have been a disaster for the island’s residents: The unemployment rate was 11.9 percent in November 2016 compared to 4.6 percent in the United States. Even that number understates the extent of the labor market dysfunction, as the labor force participation rate in Puerto Rico was only 39.9 percent in 2015 compared to 62.6 percent in the United States.
Unsurprisingly, a struggling economy in which few people are working has led to more poverty: According to the 2015 Puerto Rico Community Survey, 46.1 percent of its residents live below the federal poverty level.
Certainly, reviving the Puerto Rican economy will require a number of changes. As American Enterprise Institute scholar Desmond Lachman Resident Fellow argued, increasing budget discipline, reforming taxes and regulations, and changing the Jones Act (which artificially increases their shipping costs) would lead to more economic growth on the island. But a special focus is needed on improving the labor market and encouraging more Puerto Ricans to find employment, contribute to the economy, and better provide for their families.
Rubio has proposed a simple piece of legislation that could help Puerto Ricans return to work by reducing the minimum wage and replacing it with a direct wage subsidy. Economists have long recognized that minimum wages can reduce employment, especially for lesser-skilled workers who are unable to produce enough value to be hired by firms at the mandated wage.
Some economists say large disemployment effects can be avoided if minimum wages are set at about half of the median wage, which is roughly where the minimum wage is currently set in the United States. However, the federal minimum wage still applies in low-wage Puerto Rico, and there the minimum wage is 75 percent of the median wage. One study from the 1990s found that imposing the federal minimum wage in Puerto Rico reduced total employment by 8-10 percent compared to maintaining a similar minimum wage to average wage ratio as in the U.S.
Rubio’s EMPLEO Act would reduce the minimum wage in Puerto Rico from the federally-mandated $7.25 to $5 an hour (roughly half the median wage). This by itself could increase employment, but Rubio also recognizes the importance of properly rewarding work. He would create a government-funded wage subsidy that Puerto Rican employers would provide to all low-wage workers in every paycheck, valued at half the difference between the wage offered by the employer and the median wage (frozen at $10 for the first two years of the program).
Like the earned income tax credit (which Puerto Rican workers do not receive because they do not pay federal income taxes), the wage subsidy promises to pull more people into the labor force and reduce poverty. Existing welfare programs are likely reducing labor supply. An analysis from 2006 found that a single mother with two kids in Puerto Rico who received all available benefits and did not work would only gain an additional $37 in income per month by working full-time at the minimum wage, once welfare benefit reductions and taxes were taken into account. Both a new wage subsidy and work-focused reforms to existing welfare programs are needed to increase the incentive to work.
Rubio’s proposal would also provide a useful test of the wage subsidy approach, which the Manhattan Institute’s Oren Cass has argued could replace the EITC in the U.S. While the EITC is popular across the political spectrum and has been shown by research to increase labor force participation and reduce poverty, it also has clear problems: An improper payment rate of more than 20 percent, significant marriage penalties, and benefits that come in a lump sum check at the end of the year rather than in each paycheck.
Replacing the current EITC and its complicated structure with a simple wage subsidy might be able to resolve those flaws. But before taking such a program nationwide, we would certainly need to test its feasibility. Puerto Rico offers an opportunity to experiment with this interesting idea.
While the minimum wage reduction and wage subsidy approach will help, it is unlikely to be the silver bullet in the effort to revive Puerto Rico. Broader economic growth strategies and work-focused welfare reforms that push recipients to seek employment are also needed. However, this proposal would address two major problems facing the Puerto Rican economy — a minimum wage that prevents employers from hiring low-skill workers, and strong disincentives to work — and would be an important first step in helping Puerto Ricans leave welfare for work.
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