Policy: Budgets & Deficits

Puerto Rico's financial crisis may need a Washington solution

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Opinion,Op-Eds,Labor unions,Labor,Puerto Rico,Fiscal Policy,Entitlements,Budgets and Deficits,Pensions

After nine years of economic stagnation, Puerto Rico is in desperate need of private investment, as the island teeters on financial collapse.

Nevertheless, the Puerto Rican government has done little to foster the confidence of investors. Instead, it has embarked on a spending spree fueled by a risky cycle of taxation and borrowing that threatens to chill private investment.

Budget deficit financing became the norm. More than $70 billion in long-term debt was accumulated with little to show for it. Now, Puerto Rico's runaway spending appears to have reached its limits. Constitutional restrictions on additional debt issuance have been reached and the commonwealth's credit was downgraded to junk level.

This should be cause for great alarm not just on the island but also in Washington, where policymakers may have to step in amid increasing calls to provide a bailout that would dwarf the massive infusion of federal aid Detroit received after it went bankrupt.

Even as the government undertakes important cost-saving efforts to restructure burdensome public employees' pensions, the situation on the island becomes increasingly dire with each passing week. Most recently, a public dispute erupted between the government and one of the island's leading banks, Doral. At issue is more than $230 million that the bank claims Puerto Rico's Treasury Department owes it. The dispute has already reached the courts.

Not only is this dispute drawing renewed attention to the island’s fiscal woes, it also has the potential to send an unsettling message to investors — that the government doesn’t honor its debts.

In this context, Gov. Alejandro Padilla must fill the leadership void and lead his administration in confronting the insidious dynamics threatening the island's prosperity, including vociferous labor unions content with the status quo and a private sector convinced it is under siege by a revenue-starved government.

Up to now, the government response to the fiscal crisis has been clumsy and ineffective, to say the least. Among other things, it has sought to generate revenues entirely on the backs of middle-class taxpayers, business owners and others in the private sector who make significant contributions to the economy.

The government has come up with a barrage of senseless tax measures, such as the controversial one to require local businesses to pay taxes based on their gross income in a given year, even if the businesses actually wound up with net losses that year.

Then there is an absurd tax proposal that seeks to siphon $9.8 million a year from an agency responsible for insuring the deposits individuals have in savings and credit cooperatives. If that were not bad enough, the money siphoned from the insurance fund has a dubious purpose: to provide $50 million in subsidies to the cattle and milk industry. Fortunately, the Legislature has seen the light and this legislative proposal has no chance of passing. (We could only hope that reason prevails in the Treasury-Doral dispute with a quick settlement.)

All the while, the size of government in Puerto Rico has continued to grow dramatically, with a Keynesian excess that is being championed by a political class that appears to have forsaken the private sector. Today, 60 percent of the island’s residents rely on government for jobs or basic needs, like housing and food subsidies.

Is it any wonder, then, that Puerto Rico’s credit rating has been downgraded to junk status? Or that real estate on the island has lost about 40 percent of its value? Or that Puerto Rico is hemorrhaging capital as well as experiencing an exodus of residents seeking economic opportunity on the mainland?

For Puerto Rico to climb out of its current hole, it must make some tough decisions. For starters, it must get over the seemingly insatiable appetite is has for private-sector income. Continuing to raid the insurance fund for credit unions, or outright reneging on tax credit agreements with local financial institutions, can only have a damaging effect on the confidence of ordinary citizens and investors.

In addition, current government expenditures must be drastically cut. Hefty annual surpluses must be generated and sustained for the next decade. These savings would then be leveraged to finance a sustained investment effort strategically directed to modernize and expand the island's productive capacity.

More than that, the populist mentality that gave rise to big government must now yield to policies that shift the center of gravity in the commonwealth toward the productive sectors of the economy. And finally, the government must be willing to confront the unreasonable demands of labor unions, whose members have become accustomed to concessions that the government can no longer afford.

Only then will Puerto Rico position itself to emerge from a crisis that has the potential to ensnare U.S. policymakers as well as threaten the economic security of future generations on the island.

Elías R. Gutiérrez is a professor in the Graduate School of Planning at the University of Puerto Rico. Thinking of submitting an op-ed to the Washington Examiner? Be sure to read our guidelines on submissions for editorials, available at this link.
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