Puerto Rico's Economic Crisis: Overview and Recommendations for Action

Puerto Rico and its more than 3.5 million residents are in crisis. In June 2015, Puerto Rico’s Governor Alejandro García Padilla declared that the Commonwealth’s $72 billion debt was “not payable.” He further declared that Puerto Rico needed help from the U.S. government and creditors to restructure the debt and create a plan for sustainable economic growth.

Governor Padilla’s declaration comes after years of low employment and labor participation rates, high rates of outmigration leading to a decline in population, an economic structure shaped more by tax advantages than comparative advantages, inequities in federal health care reimbursement, and unwise, predatory lending practices by hedge funds, which own an estimated 20 percent to 50 percent of Puerto Rico’s debt.

Ramifications of the island’s economic crisis have been far reaching. The Commonwealth of Puerto Rico has effectively run out of cash to keep the government open and has turned to unprecedented emergency measures like intra-government loans and delaying income tax refunds to keep services running. More island residents have migrated to the U.S. mainland in the last 5 years than at any time since the Great Puerto Rican Migration after World War II. One hundred and fifty public schools on the island have been shuttered during that period of time. Puerto Rico has increased the retirement age, and required heftier pension fund contributions from public sector workers, and more pain is coming. Puerto Rico passed a budget for the fiscal year beginning July 1, 2015 that increased the sales and use tax from 7 percent to 11.5 percent and further reduced public investment by $674 million.

Yet economists argue that Puerto Rico cannot “cut and tax” its way out of the crisis. As the Krueger report* states, “the debt cannot be made sustainable without growth.” Many groups such as the Center for a New Economy and Fiscal Policy Institute see a need for policies that not only advance fiscal reform, but that protect the quality of life of Puerto Ricans and offers an economic vision that fosters a climate for job growth. This approach ultimately enables the island to service its debt and grow its economy without extracting such a heavy toll on low- income communities, which comprise a majority of its residents.

This briefing paper seeks to inform discussions regarding Puerto Rico’s path out of its crisis for concerned and key stakeholders in Washington, Puerto Rico and localities across the country. The first section provides a brief overview of what precipitated this dire situation and how Puerto Ricans are currently fairing. The report goes on to lay out select recommendations on how the federal government can potentially help Puerto Rico navigate and emerge from this crisis in improved fiscal shape.

The truth is this: Severe current and future government budget cuts threaten to undermine the already tenuous economic situation of hundreds of thousands of Puerto Ricans on the island. There is a good chance that the crisis will be increasingly felt in many U.S. states, through potential pension asset losses and a growing reliance on local social services by those who migrate to the U.S. In short, Puerto Rico’s near-calamitous economic crisis, if left to fester, will almost certainly reverberate far beyond the geographic limits of the island.

Puerto Ricans and other Latinos on the U.S. mainland have been warning about the potential impact of the crisis on those living both within and without Puerto Rico’s borders. As economic and financial conditions have worsened in recent months, we have partnered with community, government, philanthropic, labor and academic leaders and institutions from across the United States and the island to form a national e ort to support Puerto Rico.

We aim to take these recommendations to our nation’s leaders. Our hope is that this report will help to inform and pressure key influencers to urgently act to assist the island. To that end, we have already been engaging, educating, organizing and mobilizing stakeholders in Puerto Rican and Latino mainland hubs and in our nation’s capital. Our message is clear: Millions of American citizens in Puerto Rico are in danger of losing much of what they have unless our federal government acts with bold purpose to stabilize and grow the island’s economy. The time for action is now.

Background

The reasons behind the island’s current economic woes are complex, with plenty of blame to go around: federal funding shortfalls and tax policies that hamper economic growth, poor budget practices by the island, predatory lending by hedge funds, and the complicated and oft unjust relationship between the U.S. and Puerto Rico, to name just a few. There are also wider forces to blame, such as the Great Recession, outmigration from the island, and escalating energy and health care costs.

Setting the stage for the crisis were stagnant economic conditions in Puerto Rico over the past 10-15 years, brought about by the elimination of Section 936 of the Internal Revenue Code. Section 936 encouraged mainland companies to locate on the island. Unfortunately, when the tax breaks were eliminated by Congress, these companies moved out. The Great Recession of 2008 compounded this stagnation, leaving almost half the island’s residents in poverty and unemployed. Forced to seek economic opportunity, hundreds of thousands of Puerto Ricans moved stateside to places like Florida, draining the island’s tax base which funds basic public services.

However, structural economic inequalities – in part driven by Federal policies – date back long before the recent decline. A prime example is the burdensome cost of transporting goods created by the U.S. Jones Act, which has increased shipping costs by billions over many decades. In effect, the law requires every car, food item or other product that enters or leaves Puerto Rico to be carried on a more expensive U.S.- flagged vessel. If a foreign flagged ship enters the island, high taxes and customs fees essentially double the price of transported goods.

Puerto Rico also faces growing costs for its public services. The electricity system led by the Puerto Rico Electric Power Authority (PREPA) is more than $8 billion in debt. A recent deal to restructure the debt still leaves the challenge of reducing sky-high energy costs to homeowners and businesses from the outdated and unhealthy use of fossil fuels, as opposed to cleaner, renewable energy systems. A recent report by the Institute for Energy Economics and Financial Analysis lays out several wise recommendations aimed at lowering energy costs through systemic reforms and switching to cleaner energy mechanisms.

Federal healthcare funding inequities have also contributed to the ongoing crisis. Approximately 60% of the island’s population is enrolled in Medicaid or Medicare, both of which face an uncertain future due in part to an archaic capping of federal contributions which was imposed upon Puerto Rico. As a result, healthcare costs represent an estimated $25 billion of its $72 billion debt.

Declining tax revenue has forced successive Puerto Rican governments to keep borrowing to keep public utilities and local government running. Hedge funds looking for fiscal windfalls have been happy to oblige on extending huge loans with predatory interest rates to the Puerto Rican government. These same hedge fund interests were backers of changes in the island’s constitution that mandated the local government to first pay debt relief before continuing to fund schools, energy and other vital public services.

Unfortunately, this focus on debt payments above all else will only help to exacerbate the current vicious cycle of outmigration, with the only certainty being more pain for Puerto Rico in the future. The following pages detail the main causes of the island’s financial troubles, focusing on labor force decline, the health care crisis, and debt and debt service costs.

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