February 11, 2020
Puerto Rico: Looking Ahead
Puerto Rico remains mired in economic woes stemming from a 12-year long recession that has led to unsustainable debt, pension obligations that predated the devastation brought on by Hurricane Maria in September 2017, and significant additional damages from earthquakes in January 2020. Simultaneously, the congressionally mandated Financial Oversight and Management Board (FOMB) with broad budgetary power is slowly restructuring debt amid controversy while limiting spending during an austere and fragile economic environment.
Hurricane Maria claimed the lives over 3,000 Puerto Ricans, caused significant additional socioeconomic strain, destroyed antiquated infrastructure, and fueled further exodus. Disaster response and recovery efforts are thus far indefensible. The earthquakes have exacerbated a fragile recovery. Without necessary lasting recovery investments and growth policies, the underlying problems that led to the economic crisis may go unaddressed, the economy could stagnate or further recede over time, and restructured debt and pension obligations will fail to be realized in out-years.
Hurricane Maria was the worst natural disaster ever experienced in the United States. Puerto Rico faces challenges that would be best met through a development authority made up of federal and Puerto Rican stakeholders, which would provide for significant planning, investment, transparency, and deliverability of the resources it will take to rebuild Puerto Rico to new, resilient standards and be better prepared to meet the threats of a Caribbean island in the 21st Century. This approach was recommended in a policy paper by the Center for a New Economy (CNE), the preeminent think tank in Puerto Rico, over two years ago. Development authorities were created in New York after 9/11, and in Louisiana following Katrina. Puerto Rico would benefit from a well-coordinated and integrated approach as described by CNE.
While politicos in Washington tend to point blame at San Juan for the island’s problems, there is plenty of blame for Washington’s handling of these challenges. Congress responded to the economic crisis by enacting PROMESA in 2016. While its goal was to provide debt restructuring tools, budgetary controls, and austerity, Congress failed to provide for federal policies to help drive economic growth.
PROMESA did create the Congressional Task Force on Economic Growth in Puerto Rico. The Task Force produced a report in December 2016 – yet none of the bipartisan recommendations put forward have been enacted. The House of Representatives included the extension of the child tax credit to Puerto Rico, a policy recommended by the Task Force, in a supplemental appropriations bill in response to the earthquakes in Puerto Rico. The legislation also includes providing an earned income tax credit (EITC) that will be based on Puerto Rican tax payers’ federal tax liabilities, which is for the most part pay roll taxes. The supplemental also includes lifting the statutory cap on the rum cover over program, which provides much needed revenue to Puerto Rico, and which was also recommended by the Task Force. The two individual credits and the rum cover over are good initial steps forward.
But Congress and the administration must partner with Puerto Rico to address the need to restore sustainable economic growth to Puerto Rico and to invest in healthcare and critical infrastructure that will make Puerto Rico the shining example in the Caribbean and a Latin American powerhouse within the United States. Prime Policy Group has represented a variety of clients in Puerto Rico for decades. We are closely attached to our common citizens there and feel that too often the blame is left at Puerto Rico’s doorstep, when much of the blame rests before administrations past and present and with Congress.
Industrial Tax Policy
Puerto Rico’s economic and fiscal crisis is due in great part due to the decision in Washington to repeal the possession tax credit, which was in Section 936 of the U.S. Internal Revenue Code. The 10-year phase out of 936 began in 1996 and ended in 2006 – the very year the recession in Puerto Rico began. Since then, the island’s economy has suffered a drastic contraction of total production, a depression-like decline in employment, and a massive wave of outmigration. Puerto Rico’s labor force of 1.2 million people has lost over 100,000 manufacturing jobs. It is hard to contemplate an economy the size of Puerto Rico’s losing more than 100,000 well-paying manufacturing jobs in a decade. Fueled by the manufacturing downturn, the real Gross National Product (GNP) of Puerto Rico declined 15% during the recession. There is no other U.S. jurisdiction which has experienced such a prolonged and deep contraction in output. The underlying force which created the downturn was the Washington-driven decision to repeal 936. The resulting deficit financing in San Juan – sold by Wall Street bankers and lawyers as a necessary bridge over a supposed temporary recession – created the fiscal crisis and bankruptcy.
Despite having lost over 100,000 manufacturing jobs due to the phaseout of 936, manufacturing still represents half of the Puerto Rican economy. The manufacturing downturn has driven Puerto Ricans away to seek better employment opportunities and benefits in the 50 states, leaving Puerto Rico in droves. Puerto Rico’s population had plummeted by more than 500,000 people over the course of the recession and in the aftermath of Hurricane Maria. This resulted in a dramatic reduction in economic activity, and therefore in revenue collection by the cash-strapped Puerto Rican government.
Congress and the administration should return to a 75 year-long precedent of partnering with Puerto Rico behind policies that provide reciprocal benefits to Puerto Rico, the mainland, and to vested stakeholders. Puerto Rico is treated as a foreign jurisdiction for tax purposes; it competes with Ireland and Singapore for high tech manufacturing jobs. Since 2006, Congress has walked away from the precedent of treating Puerto Rico with distinction, and the result has been recession and economic crisis.
A new competitive differential for Puerto Rico-based manufacturing and its U.S. citizen workforce will foster growth and investment and make up for jobs and product lines lost to foreign jurisdictions over the last 20 years. It will provide for revenue growth and ways to service the debt and make good on pension obligations. The rationale for this treatment is to enact growth policies that produce jobs and investment under the U.S. flag for U.S. citizens.
The AJCA imposed on all foreign tax jurisdictions, Puerto Rico included, base erosion taxes to attempt to prevent U.S. firms from offshoring manufacturing. A very simple solution that would create significant new investment and job growth in Puerto Rico would be to limit or eliminate the base erosion measures’ application to Puerto Rico, including the global intangible low-taxed income (GILTI) tax.
The costs of the phaseout of 936 are clear. It’s time to reverse course and to restore the partnership with Puerto Rico through the federal tax code.
Healthcare Policy / Medicaid Funding
Puerto Rico is subject to an annual cap pursuant to Section 1108 of the Social Security Act (42 U.S.C. 1308). Once the annual federal funding cap is reached, the bankrupt Puerto Rican government is responsible for the remaining cost of all Medicaid services. The cap has created unsustainable financial burdens and limits access to federal healthcare programs. The Affordable Care Act (ACA) increased funding for Medicaid programs in Puerto Rico but did not make the increases permanent. Since additional funding provided in ACA has run out, Congress has been enacting extensions of the increased funding to help keep programs in Puerto Rico running. President Trump recently objected to a four-year increase in Medicaid funding for Puerto Rico, cutting in half a deal reached in the House that would have provided for some $12 billion to Puerto Rico over four years. Instead, Puerto Rico will receive $5.7 billion over two years.
Healthcare should be treated as a right not a privilege. Congress should provide Puerto Rico and the smaller island territories Medicaid funding by the same formula it gets provided to states, or through the Federal Medical Assistance Percentage (FMAP), which is computed through the average per capita income for each jurisdiction relative to the national average.
Increases in federal healthcare funding must be realized through transparent and efficient delivery of services to the citizens in Puerto Rico, who deserve access to and delivery of first-rate healthcare. Additional mitigation funds appropriated by Congress in response to Hurricane Maria can be invested in healthcare networks that will help ensure the delivery of the best healthcare services available.
The federal government should partner with Puerto Rico in meeting goals to convert from existing reliance of fossil fuels toward 100% renewable energy production by 2050, as identified under Puerto Rican law and exemplified in Hawaii. Puerto Rico Energy Bureau’s oversight of the Puerto Rico Electric Power Authority (PREPA) is critical to future success. In order to best compete in the global marketplace and provide for clean air and environmental stewardship, PREPA must be transformed from a corrupt and bankrupt authority to a modern-day efficient and transparent authority. Energy costs must be reduced, and system reliability and sustainability realized for all rate payers. The inclusion of a toll charge within PREPA’s Restructuring Support Agreement (RSA) will only drive energy costs higher in Puerto Rico, further delaying necessary economic expansion.
Why not create for Puerto Rico what President Roosevelt helped create in the Tennessee Valley Authority under Roosevelt’s New Deal program? Such bold changes could foster transformation of Puerto Rico’s energy production and distribution and make it an example for similar island jurisdictions to follow.
In addition to delivering disaster recovery and mitigation funding appropriated by Congress in the wake of Hurricane Maria, a development authority and infrastructure bank should be created to invest in critical surface, maritime, and aviation transportation-related projects, as well as to ensuring modern telecommunication, flood protection, and water and sewer upgrades are identified and funded over time in Puerto Rico.
Despite years of suffering and battling its ongoing challenges, Puerto Rico is primed for lasting solutions to its socioeconomic and critical infrastructure-related challenges. We are proud and grateful to know the resolve and talents of its people. Puerto Rico’s best days lie ahead – provided we realize a new partnership led by the people of Puerto Rico with committed and thoughtful leadership in Washington.