Reforms For A More Prosperous Puerto Rico

With the end of the federal stay, Puerto Rico’s Governor has announced that the territory intends to file for bankruptcy protection. A protracted fight in the courts, which will distract from the fundamental problems facing Puerto Rico, appears inevitable.

For those who have not been paying attention, Puerto Rico is facing an extraordinary crisis. The economy has declined in 9 out of the past 10 years; the government has amassed $73 billion in debt that it does not have the capacity to repay; the territory’s infrastructure is crumbling; and the health care system is failing. The problems with the health care system are particularly important as nearly 70 percent of the Island’s residents rely on either Medicare or Medicaid.

Like the debt crises plaguing many countries (e.g. Greece), simply throwing more money at Puerto Rico will not solve the territory’s fundamental problems. Seen from this light, the additional $295 million in Medicaid payments that the FY2017 federal budget agreement has allocated to Puerto Rico will only bear fruit if structural fiscal reforms are also implemented.

This is why when Congress passed the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) in June 2016, it established a control board. The Control Board is supposed to help Puerto Rico create a long-term plan that addresses the current problems and puts the territory on the path to prosperity.

Returning Puerto Rico back to fiscal health requires broad based reforms including overhauling the tax system, improving the business environment, rightsizing the government, and creating a sustainable solution to the debt crisis that includes reforming public pensions.

Starting with tax reform, Puerto Rico’s current tax system doles out favors and is plagued with compliance problems (the current compliance rate is a mere 56 percent according to an assessment of Puerto Rico’s tax system by KPMG).

Furthermore, the tax system is complex, with a statutorily high tax rate on corporations and individuals. Instead of its complicated and progressive tax system, Puerto Rico should learn the lessons from Hong Kong and implement a simple flat tax system that would simultaneously encourage economic activity and tax compliance.

Relatedly, Puerto Rico’s business environment is notoriously uncompetitive. As documented by the Federal Reserve Bank of New York, Puerto Rico promulgates costly regulations and creates other bureaucratic obstacles that make it difficult for businesses and entrepreneurs to thrive.

Eliminating these government created obstacles will incent greater business investment, increase jobs, create an incentive for many of the educated Puerto Ricans who left to emigrate back, and expand the tax base making it easier for the territory to overcome its current fiscal challenges.

While such reforms can help ease the burden over the longer term, there are very difficult challenges that must be managed in the short-term. These challenges begin with rightsizing the government. For instance, the Puerto Rico electric utility (PREPA) is infamously inefficient and opportunities exist to apply best practices to reduce costs and increase efficiencies at PREPA. Similarly, spending on health care and education need to be scrubbed for potential savings and efficiencies.

Of course, the elephant in the room is the $73 billion debt problem. These costs are currently unaffordable and changes must be made. However, the long-term costs from a disorderly process or from randomly violating the rights of select creditors, will be severe.

Because bankruptcies are long and messy processes, Congress, and the PROMESA oversight board should step in to encourage continued negotiations between Puerto Rico and its creditors. An equitable outcome is possible, but it requires good faith negotiations on all sides that includes properly accounting for the seniority between the 11 different types of debt issuers.

Additionally, it is important to treat the future obligations of pensioners and employees equally with all other creditors – after all, ultimately, the holders of many of Puerto Rico’s bonds are private individuals who are either pensioners themselves, or workers nearing retirement. Therefore, the interests of one set of pensioners should not be held above the interests of another set.

Undoubtedly, due to years of mismanagement, Puerto Rico is in a difficult position. But, this rocky economic past does not need to define Puerto Rico’s economic future. In the short-term, fiscal discipline coupled with a fair (and legally based) plan to address the debt crisis can solve the near-term problems.

Implementing structural reforms that encourage economic growth and improve Puerto Rico’s business competitiveness in the long-term can offer a more hopeful future of stronger economic growth and increasing prosperity.

Wayne Winegarden, Ph.D. is the Managing Editor for EconoSTATS and a Sr. Fellow in Business and Economics at the Pacific Research Institute

Wayne Winegarden
Reforms For A More Prosperous Puerto Rico