Puerto Rico’s “Growth Plan” That Isn’t

By David R. Martin

EspañolAt the agonizing heart of Puerto Rico’s fiscal and economic crisis is a malignant devotion to two false deities. The first are low but regressive taxes that deprive the government of the ability to fund itself while overburdening the poor and working class with stratospheric consumption taxes. The second is a preference for economic activities in which the island is not competitive.

With absurdly low tax revenues that hover at just 10 percent of GDP, the government has regularly sought the path of least political resistance by borrowing (even beyond its legal debt limit) to make up for persistent revenue shortfalls.

Even after supplementing revenues with borrowed funds, public spending is usually around 11 percent of GDP, still far below the 34 percent average spent by governments of rich, developed jurisdictions. It should come as no surprise, then, that Puerto Rico lacks basic quality public goods and services that are key criteria in attracting investment and job creation.

Yet none of these circumstances seems to inform the Fiscal and Economic Growth Plan (FEGP) released by the US island territory earlier in September.

The FEGP is doubly alarming. First, in addition to the “unpayable” headline debt of US$72.2 billion, the island of 3.5 million residents has unfunded pension liabilities of $43.4 billion, which are abashedly relegated to a footnote of the FEGP. Second, the steps proposed by the government to address this dire scenario are grossly underwhelming.

To borrow a term used by former US Treasury Secretary Larry Summers, this is no time for gradual incrementalism. The island needs bold, transformational structural reforms to escape not only the current crisis, but also depart from a long track record of economic underperformance.

Crucially, the government must cast into the dustbin of history the tax-exemption based economic-development model. It simply does not work. From the 1970s to 2006, when enormous federal tax breaks were in place, the island regularly lagged behind the US mainland in employment and labor participation.

Indeed, when I returned to the island after graduating from college in 1984, unemployment was 20 percent (as opposed to 11.6 percent today). And it remained so until 1993, three years after I relocated to the US mainland. High unemployment during this period existed even though the massive federal tax subsidy, known as Section 936 of the US Internal Revenue Code, was operating at full bore.

Tax-driven investments in Puerto Rico bring lumpy results that are largely decoupled from the rest of the island’s economy. The favored industries have no real reason to operate on the island other than a dubious tax dodge that is under siege by most advanced countries, including the United States. High-tech manufacturing, pharmaceuticals, and chemicals production employ just 6 percent (and shrinking) of the island’s workforce, but account for more than 50 percent of GDP.

Meanwhile, tourism is given short shrift. Amazingly, despite being one of the few consistent growth sectors, tourism is mentioned nowhere in the FEGP. With just 15,000 hotel rooms, Puerto Rico potential as a tourism and entertainment powerhouse is still on the ground floor.

Instead, alongside other copycat tax havens in a race to the bottom, the Puerto Rico government has doubled-down on its tax-exemption based model. Included among the FEGP proposals is a request for Congress to reintroduce a bill for a special federal tax break known as 933A.

The folly of this idea is extraordinary. As it already did in the recent past, Congress will reject additional special tax treatment funded by US taxpayers. Moreover, this proposal shows that those in charge of Puerto Rico’s economic development policies utterly failed to learn how precarious one’s existence is when it depends for survival on federal subsidies.

Without radical policy departures to repeal tax exemptions, increase public investment in education and safety, remove bureaucracy, and make employment at-will, there will be no fundamental change.

And along with massive, targeted upgrades of its infrastructure, the government must foster inherently competitive activities that are truly aligned with Puerto Rico’s privileged climate, as well as its proven human talents in the arts, entertainment, and sports.

Without these vital changes, this beautiful US island territory in the Caribbean will continue to flounder.

David R. Martin is a corporate lawyer, member of the Puerto Rican mainland diaspora, and author of Puerto Rico: The Economic Rescue Manual. Follow @DRMartinLLC.

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