Solving The Puerto Rico Debt Crisis: Policy Priorities for Congress

Puerto Rico’s current crisis has been years in the making and is not solely limited to the public debt overhang. At the core of the current predicament is a deteriorated development model and institutions that have hindered growth. Thus, any solution enacted by the federal government must recognize the multifaceted nature of the crisis. Following are the Center for a New Economy’s key recommendations regarding the proposed Puerto Rico Oversight, Management, and Economic Stabilization Act.


Key Policy Priorities

1. BROAD RESTRUCTURING AUTHORITY
If Puerto Rico does not address its debt overhang problem effectively it will be unable to attract the private capital necessary to generate sustainable economic growth in the future. Thus, it is important that broad restructuring authority be preserved in the final bill text. By “broad authority” we mean authority to restructure all of Puerto Rico’s debt, if necessary, including General Obligation and COFINA bonds. Past experience with sovereign restructuring indicates that partial or incomplete restructurings are usually followed by another restructuring or default within five years.

In addition, the bill should also include, at a minimum, an automatic stay on litigation to preserve the government’s ability to keep providing essential services and a clear rule for preventing holdouts from blocking a reasonable compromise.

2. SCOPE OF THE OVERSIGHT BOARD

The powers of the Oversight Board as currently proposed are unjustifiably far-reaching and unnecessarily intrusive. A Federal Fiscal Control/Oversight Board for Puerto Rico solely focused on imposing “quick fixes” and addressing public debt issues runs the risk of failing to solve the crisis. If Congress wants to avoid facing the same predicament in 5 or 10 years, any solution crafted in the current juncture must ensure the long-term transformation of the island’s fiscal and development infrastructure and have the support of diverse stakeholders in Puerto Rico.

Our proposal is as follows:

a. A locally drafted and enacted Fiscal Responsibility Law that outlines a Fiscal Rule regarding the government budget can get the fiscal house in order; become a point of convergence of local stakeholders in Puerto Rico’s polarized political scenario; serve as a trigger for change; and more importantly, activate a broader and longer-term overhaul of the island’s fiscal institutions. Such a Fiscal Responsibility Law would limit general fund spending to (i) cyclically adjusted revenues, as determined and certified by an independent panel of professional economists and other fiscal policy experts, minus (ii) a small structural surplus.

b. Rather than a stringent over-reaching Control Board, we suggest that the powers of the Oversight Board be limited to monitoring the implementation of and compliance with the Fiscal Rule and the Five-Year Fiscal Plan. The Oversight Board would have technical, monitoring and training functions, and would provide the technical assistance to help Puerto Rico’s elected officials set spending limits and surplus targets; monitor compliance; and assist in the technical aspects of the Fiscal Rule and Five-Year Plan’s implementation. Within those constraints, agency heads and legislators in Puerto Rico should have programmatic flexibility to appropriate and spend funds according to local priorities.

In our opinion, review of all legislation and contracts by the Oversight Board, as contemplated in the current version of the Bill, is too cumbersome and onerous. The same can be said about the current language granting the Oversight Board broad authority to implement recommendations regarding the financial stability, management responsibility, and
service delivery efficiency of the Government of Puerto
Rico (even over the Government of Puerto Rico’s objections). This kind of bureaucratic micromanagement may entangle the Oversight Board in contentious political disputes with the Government of Puerto Rico and local stakeholders. We recommend the Oversight Board focus on providing technical assistance to the Government of Puerto Rico to implement budgeting practices in compliance with modified accrual accounting standards, improve its fiscal operational and executional capabilities, including hiring of qualified human resources, establishing integrated financial management information systems and improving internal control, internal audit, and real-time monitoring capabilities. If the Government of Puerto Rico fails to implement those recommendations, then the Oversight Board, in order to safeguard and ensure the proper use of federal funds, should have the discretion to withhold federal funds allocated to the Government of Puerto Rico until it has substantially improved its public financial management system.

3. ECONOMIC AND FISCAL STABILIZATION

Unless short term stabilization measures and a long-term commitment to generating growth is included, any policy risks falling short of resolving Puerto Rico’s drawn-out economic crisis.

a. Economic Stabilization — We suggest considering a graduated employment subsidy, such as the one designed by Nobel Prize-winning economist Edmund Phelps. His proposal is based on establishing a graduated scale of decreasing wage subsidies, which are phased out slowly and smoothly. In Puerto Rico, the subsidy could be implemented for employees that earn wages below the minimum (for example, waiters and agricultural workers) up to workers that earn 150% of the median wage. Employers who increase wages in this way would get a tax credit against the employer portion of the federal payroll tax. This proposal, or something similar, could be applicable to Puerto Rico since Puerto Rico employers pay full payroll taxes. This type of program would not affect the long-run costs of employers while providing a strong incentive to work in the formal economy.

b. Fiscal Stabilization — We suggest that Congress gradually treat Puerto Rico as a state with respect to Medicaid funding over the next ten fiscal years.

4. ECONOMIC GROWTH

We recommend that the bill include a new section requiring Congress to set up a joint task force or working group to collaborate with an Economic Growth Commission to be set up in Puerto Rico with representatives from the island’s civil society, business sector, labor unions, government, and academia, to develop a medium-term economic growth strategy for the island.

 

Other Important Issues

  1. Minimum Wage — We suggest eliminating this section in its entirety. It is not clear to us how lowering the minimum wage, in an economy with an extremely low labor force participation rate and a large informal economy (consisting of both legal and illegal activities), will provide a positive incentive for working in the formal economy to people who already are out of the labor force or working in the informal economy.
  1. Board Composition — We recommend that two of the members of the Oversight Board be selected and appointed by the President and the other three be chosen from lists submitted to the President by the Speaker of the House, the Majority Leader of the Senate, and the Governor of Puerto Rico.
  1. Pensions — We recommend that the Joint Board for the Enrollment of Actuaries, in executing the study of Puerto Rico Pension Plans be required to consult with at least two pension plan experts recommended by the board of trustees of each of the Puerto Rico Pension Plans.