Fixing Puerto Rico: Part III

By: Frank Worley-Lopez - Jan 22, 2014, 8:46 am

Read: Part I, Part II, and Part IV.

As we have discussed here, the Commonwealth of Puerto Rico faces a massive debt problem. I’ve also discussed the importance of basic math in solving Puerto Rico’s problems. However, I would to take time and get a little more specific.

If you are a liberal/progressive, you view Puerto Rico’s financial situation (and the United States’) as a revenue problem. If you are a conservative or libertarian (I’m actually both) then you see it for what it really is: a spending problem. When you factor in Puerto Rico’s declining population and tax base, 14 percent plus unemployment rate, and only about 1 million of the island’s 3.6 million people actually in the workforce (a third of those employed by government at some level), then there is not doubt: Puerto Rico spends too much money for its current resources.

Fixing this aspect of the troubled US territory is as simple as it is painful: cut spending. However, cutting spending now will only fix today’s problem for a short time. In order to actually fix the problem, the government must address the fundamental reasons it got into deficit spending in the first place.

The Primary Drivers of Expenses?

I won’t take the time to dissect the budget for the island over the last 10 years; I will leave that to the elected politicians. However, when one third of your employed population is employed by the government and the public is on the hook for their retirement, you probably don’t need to look beyond payroll and pensions to find the immediate solution.

The first equation Puerto Rico needs to use is this one: R-E, revenues minus expenditures. While revenues are up, according to the Puerto Rico Treasury Department and Government Development Bank, and while some effort has been made to curb pension costs, the result of that equation is still a negative number. This fiscal year is underway and there are roughly 9 months left (and a hurricane season) so there is no way to clearly judge what the final numbers will be for this year — but the previous seven years tell a very sad story.

There are a lot of numbers in that Bloomberg article and the others I’ve referred to in past articles, so let’s use a simple number to start with as an example. If your total budget is US$10 billion dollars and you only raise $9 billion in revenues, you have few options: raise taxes quickly, borrow money and raise taxes later, or cut spending by 10 percent ($1 billion to make up the shortfall).

Politicians hate pain, especially pain that might be inflicted on the majority of voters so borrowing money and raising taxes later is always the preferred plan. That is especially the case when you consider that the tax increase is probably not going to affect most of the population, since they are not employed and live on government subsidies.

The right choice, of course, is to cut spending. That may also mean cutting services in some cases, but with as many people as the government currently has on the books, it’s a wonder they do anything other than show up and fill out their time sheets. Okay, maybe that’s too cynical; but seriously, couldn’t you cut everything except police, fire, and emergency services by enough to balance the budget now without affecting the most important matters for citizens?

The Puerto Rico Department of Education has close to 30,000 teachers and nearly 20,000 non-teaching employees, including support personnel and principals. These non-teaching employees also recently joined teachers on a two-day strike over pension reform. One wonders if all of those employees are really needed?

Cutting half of those non-teaching employees (about 9,000) would represent a 20 percent reduction in salary, benefits, and retirement expenses over time. With a cut like that, the department would actually be able to raise salaries for remaining teachers without changing anything else in education.

I operate under the assumption that similar cuts could be made across the board in nearly all government agencies until R=E.

Sustainability and Unfunded Liabilities

The next equation Puerto Rico should look at is FR-FE: future revenues minus future expenditures. If a minor reform to teachers retirement caused a strike, get ready for wide spread unrest when you address this issue.

Future revenues can’t always be estimated with the same accuracy as future expenditures. Expenditures are authorized by law and appropriated by the government, which means that, outside of disasters and other variables, the government has a relatively clear picture of how much they will need down the road. Like the United States, with its ridiculous $205 trillion in unfunded liabilities, Puerto Rico’s debt and future liabilities exceed what revenue could be generated by even a one-off 100 percent tax (confiscation) on all incomes and profits — especially since such a tax rate of that proportion would shut down all economic activity and thus result in zero revenue the following year.

So the legislature will have to address directly the causes of those future liabilities, while at the same time ensuring the payment of outstanding debt. Those changes will hurt and may require even more layoffs and more pension reforms.

However, some of it could actually be helpful.

Cutting regulations and eliminating or combining entire departments, privatizing (no, I mean really privatizing) public education, public utilities, and even workers compensation could save billions both in the short and long terms. All of this, however, will require confronting and standing up to public sector unions.

Fixing Puerto Rico’s fiscal problems will take discipline and courage. Two elements that are not in great supply in local politics. I’ll take on discipline, in a future article.