Remember Puerto Rico?
This summer, the economic woes of the U.S. territory were the stuff of headlines — which told of an unsustainable debt burden resulting from slow economic growth, a weak labor market, population outflows and poor fiscal management.
The headlines soon faded, but all the problems remain, which is what you’d expect given the government’s $72 billion debt, which it cannot realistically service.
Potential progress, however, has at last been made, as the Obama administration has come up with a plan for the commonwealth that has a lot to recommend it. The plan has three basic parts: bankruptcy, oversight and help for the less-advantaged citizens of Puerto Rico.
Before we get to the merits of the new plan, a brief bit of background. As is all too often the case, whether we’re talking about Greece, Detroit or Puerto Rico, the problem often begins with a fundamental mismatch between growth and debt. There’s nothing wrong with borrowing, especially when it’s on behalf of productive investments; in fact, to not do so risks underinvestment in growth-promoting public goods. But Puerto Rico basically borrowed year after to year to meet operating costs, while its economy flat-lined. When you do that, your debt burden grows faster than your income, invoking the unforgiving arithmetic of over-indebtedness.
Since the mid-2000s, the island’s real GNP is down about 10 percent and unemployment is in double digits (we use GNP — gross national product — for Puerto Rico instead of GDP because the former excludes income that leaves the island and is not available for residents). Poverty is high, incomes are low, and the public debt burden surpasses the GDP. Bond markets see that profile and build a big risk premium into any loans to the island, meaning that financing their debt has become expensive. At this point, a third of Puerto Rico’s revenue goes to debt service compared with 5 percent for the median U.S. state.
That’s not sustainable, and unless remedial action is taken, the government of Puerto Rico will soon have to choose between paying its creditors and providing vital services. As a U.S. Treasury official put it, “without congressional action, the situation could become a humanitarian crisis.” Simply put, these are our fellow citizens and we must help them. They must also help themselves.
First, Congress must allow Puerto Rico to restructure its debt in federal bankruptcy court. To be clear and explicit, bankruptcy isn’t a bailout. No taxpayer dollars are involved. Creditors take a haircut, of course, but there is no feasible scenario wherein that doesn’t occur.
Second, there has got to be some give and take here. As part of the package that provides the Puerto Rican government the ability to restructure its debt, it must accept fiscal oversight from an independent, outside board. Puerto Rico’s fiscal budgets have consistently inflated revenue projections and hidden structural deficits. To ensure that we’re not back here again soon, the commonwealth needs technical oversight to craft and stick to a sustainable fiscal plan.
These measures will help get Puerto Rico back to the starting line, but growth-oriented changes targeted at the island’s weak labor market are also essential. Right now, the labor force participation rate on the island is a low 40 percent (the comparable rate for the mainland is 62 percent). This rate may be biased down somewhat by workers in the “informal” sector, i.e., off the books, but even in the formal sector, wages are much lower than on the mainland. The Puerto Rico median wage is about $9.40, compared with more than $17 on the mainland. Consumer prices, as far as I can tell, are not much lower in Puerto Rico, so these differences are real.
That is why one of the best parts of the administration’s plan is to bring the federal earned-income tax credit to Puerto Rico. The EITC is both strongly pro-work and one of our most effective poverty reducers, lifting over 6 million people out of poverty in 2013. But while the program is popular with policymakers across party lines, it has never been in place in Puerto Rico.
Some argue that this is because Puerto Ricans pay no federal income tax. But that argument is doubly flawed. First, working Puerto Ricans face the payroll tax; second, most Puerto Rican households, and virtually all that would be eligible for the EITC, have incomes too low to qualify for a federal tax liability. They wouldn’t be paying federal income tax even if the island were covered by it. These characteristics make Puerto Rico an excellent candidate for the EITC (with one caveat … read on).
The plan also proposes to treat Medicaid in Puerto Rico more fairly than has heretofore been the case. In the states, particularly the 30 (including DC) that have now accepted the Medicaid expansion under President Obama’s health-care reform, the program provides full health-care coverage for low-income households. But in Puerto Rico, where 60 percent of the population is on the Medicaid or Medicare rolls, Medicaid funding is capped at about $300 million per year; any spending above that level must be paid for out of the commonwealth’s budget. As Edwin Park points out, the health reform act “provided a one-time Medicaid boost of about $5.5 billion. But Puerto Rico spent about $2.3 billion of it as of 2014 and is expected to exhaust the rest well before 2019, the last year for which it’s available.”
Moreover, while low-per-capita-income states get a federal match on Medicaid funding of over 80 percent, Puerto Rico’s match rate is only 55 percent. And when you factor in the spending cap, the effective match rate is somewhere between 15 percent and 20 percent.
Thus, the federal government provides much less support for Medicaid “eligibles” in Puerto Rico than in most mainland states (and, of course, the feds provide no EITC support). This reality creates major fiscal stress for the territory, and it means that simply by relocating, low-income Puerto Ricans can gain access to help they can’t get if they stay home. Surely that’s a factor behind Puerto Rico’s outmigration.
Unlike bankruptcy, providing mainland-level EITC and Medicaid benefits to Puerto Rico has a budgetary cost. I’ve not seen official estimates, but in a recent congressional hearing, Puerto Rico’s representative, Pedro Pierluisi, said introducing the EITC (and expanding the child tax credit, which is in place in Puerto Rico but has restricted eligibility) would cost less than $1 billion per year. That’s not nothing, but it’s a worthy investment in the well-being of a group of Americans who face disadvantages simply by dint of where they live.
There’s one piece of the puzzle, however, that isn’t in the plan but should be. The EITC helps you only if you have a job in the formal economy. The wage subsidy will probably help move some jobs from the informal to the on-the-books side of the job market — otherwise workers will be leaving real money on the table. And by spending their extra earnings, they will help boost labor demand a bit — call it an EITC multiplier effect.
But Puerto Rico’s unemployment rate — around 11 percent — is more than twice that of the mainland, and more needs to be done to boost labor demand. Given that the island’s infrastructure needs real work, adding such an investment to the deal either through a grant or a loan guarantee would boost its impact. Obviously, that’s an awfully heavy political lift. Mainland citizens may rightfully ask, “Why there, not here?” But such demand-side measures would complement the supply-side ones.
Even if adding infrastructure investment is one (crumbling) bridge too far, the deal still maintains a smart balance between debt restructuring, necessary oversight and help to the people of Puerto Rico. We may be separated by ocean, but the Puerto Rico problem is a U.S. problem, and it’s not going to solve itself. Thus, the sooner this plan can be implemented, the better for all of us.