Who Will Foot the Bill for Puerto Rico?
Puerto Rico is the ring for the upcoming match between creditors and Congress over its debt crisis. The tiny commonwealth island of 3.5 million people has managed to rack up more than $72 billion in debt -- more than its governor Alejandro Garcia Padilla says it can pay back. Puerto Rico borrowed the money for its government to cover operating costs.
The Senate and House of Representatives are rushing to remedy the issue before July 1, when a $2 billion payment is due -- and all hell will probably break loose, because Puerto Rico simply does not have the money. If the debt is not restructured, Puerto Rico will default on its loans and its creditors may sue the island to pay its debt back at the cost of basic services. Schools, hospitals, and the police force would have to shut down.
How did Puerto Rico get into this dire situation?
Poor Mainland Tax Policy Started the Island’s Woes
Its problems are rooted in an outdated tax policy. During the 1970s, Congress, wanting to bolster the island’s industrialization process and fearing major firms would move overseas to avoid taxes, approved corporate tax incentives that allowed corporations to set up in Puerto Rico without having to pay any federal taxes. This created a manufacturing boom and companies raced to set up on the island. However, because foreign investment was made attractive artificially, it created a bubble that was bound to pop as soon as the U.S. tax code changed.
This is exactly what happened in the 1990s. Americans began to think of the previous tax code as a way for large companies to avoid paying taxes, and the U.S. government started cutting these tax breaks. After a 10-year period, Puerto Rico had the same corporate tax levels as the rest of the U.S., so it no longer had its previous advantage.
The island fell into a deep recession in the mid-2000s and has never recovered.
Puerto Rico is in a Financial Quagmire Because It Is Not a State
Even though Puerto Ricans are U.S. citizens, serve in the military, host four different military bases and pay federal taxes, it is not a U.S. state and is therefore barred from Chapter 9 protection in bankruptcy. This is different from personal or corporate bankruptcy in that Chapter 9 is reserved exclusively for municipalities to restructure their debts. Revising Chapter 9 to include Puerto Rico is politically unfavorable because it is likely to be seen as another bailout. Since it is not a sovereign nation, it can’t get funds from the International Monetary Fund either.
So what can Puerto Rico do?
Puerto Rico Started the First VAT in the U.S.
Well, it implemented the first value-added tax (VAT) in the United States this April. VATs help governments increase revenues without having to increase retail sales taxes. Because they are implemented at the supply-chain level, they are hard to dodge out of even with shrewd accountants. This is likely to boost government coffers some, but it’s a drop in the bucket compared to Puerto Rico’s overall debt.
Puerto Rico Has Undergone Austerity Measures at an Unfair Cost
Austerity is another option. Puerto Rico has cut social spending – including the shutdown of more than 100 schools -- in order to pay back its loans. It hiked the sales tax from 7 percent to 11.5 percent last year -- the highest in the U.S. Investors are calling for further action. However, this rightfully has caused massive outrage. Almost half of its residents are impoverished, and its unemployment level is more than twice the U.S. national average.
Investors bought Puerto Rican bonds that were particularly attractive due to their triple tax exempt status -- they are taxed neither by federal, state nor local governments -- even as it became clear that the island’s financial sector was out of control. This massively drove up debt -- from 63.2 percent of GNP to 100.2 percent of GNP from 2000 to 2015. These now are referred to as vulture funds because of the huge advantage to investors, who are now insisting Puerto Rico shut down essential services for its impoverished residents so they can make their profits.
PROMESA Places an External Board to Restructure Debt
Congress is currently debating the PROMESA bill, designed to create a seven-member board to oversee the island’s finances and restructure its debt.
Many Puerto Ricans are against the bill because Puerto Rico does not have the ability to elect Congressional members, and yet, they will be forced to pay for and submit to a board of Congress’s choosing. The board can sell public assets. There are also sketchy clauses in the bill in which board members may accept gifts.
Senate Finance Chairman Orrin Hatch told Bloomberg that House of Representative leaders “feel very confident” that the bill will pass. It must pass before the looming July 1 deadline for Puerto Rico’s next debt payment. The bill is not ideal by any means, but it would definitely be better than Puerto Rico defaulting on its loans and being forced to shut down the island government. Congress isn’t likely to let U.S. citizens be forced to live in third-world conditions.
So who will ultimately foot the bill for Puerto Rico? Even though its financial woes were born from tax policies that favored the wealthy and large corporations, its debt will likely come from the backs of the largely impoverished people of Puerto Rico.