Economic and Fiscal Reconstruction Plan 2009

Source: Government of Puerto Rico

INFORME AL GOBERNADOR DE PUERTO RICO sobre RECONSTRUCCIÓN FISCAL

January 8th 2009

• Puerto Rico atraviesa por una de las peores crisis económicas y fiscales de su historia. La crisis económica y financiera mundial, la recesión económica local en los últimos 3 años, y la larga trayectoria de nuestro gobierno de incurrir gastos en exceso de
  ingresos y utilizar fondos no recurrentes o financiamientos para pagar gastos se han combinado para poner a nuestro gobierno en una situación crítica que requiere que el gobierno tome medidas severas e inmediatas para enfrentar la situación.
• Sólo hay tres maneras de resolver la brecha entre ingresos y gastos: aumentar los ingresos, reducir los gastos o financiar el déficit. Esta última está disponible de manera muy limitada, a consecuencia de la contracción en los mercados de valores, y
  sólo si viene acompañada de otras medidas conducentes a resolver el déficit mediante aumentos de ingreso y reducción de gastos. El pretender financiar el déficit indefinidamente y sin estar acompañado de estas otras medidas, resultaría en una degradación de la clasificación de crédito de nuestra deuda, lo que tendría
  repercusiones nefastas.
  source: Government of Puerto Rico

Performance of 2006

Puerto Rico is noted for its diverse output performances between their industrial and service sectors. Manufacturing ranks as the country’s highest contributor to GDP earnings (estimated around 44% in 2006).However, the economy’s GDP growth performance of 2006 stood at a negligible 0.6%. Puerto Rico’s sugar industry output has diverged to trivial levels, and as of recent, production of livestock replaced this industry as being the main revenue earner for the country’s agricultural sector. Moreso, the unpredictable nature of tourism has become a main source of income (with fluctuating tourists’ arrivals, as they increased in 2004 to 5 million and then decreased to an estimated 3.9 million in 2006). [Sources:Puerto Rico Economy,:Encyclopedia-Puerto Rico]

Understanding the Post World War II trend in Puerto Rico

Upon further investigation, fiscal operations seemed to be the most integral part of the economy’s demise. A summary on the article, “The Economy of Puerto Rico” (second chapter), Bosworth and Collins examined the level and growth of production and income in Puerto Rico. A U.S. Tax code introduced in 1976 provided strong incentives for U.S. corporations to exploit profits from Puerto Rico (U.S. companies benefited by being exempted from U.S. taxation). This created a distortion of estimating Gross Domestic Product of the country, and ‘adjusted’ GDP estimates from the authors suggests a 20% cut in the level of Puerto Rican GDP by 2003. The tax policy as quoted “has done a disservice to Puerto Rico by providing U.S. corporations incentives for investment with few or no employment or local linkages.”

Between the periods 1950-75, Puerto Rico’s economy growth rate was comparable to that of East Asia, Ireland, and Latin America; output rates per person averaged around 5% a year. The economy was then characterized by its efficiency of factor usage. But after 1975, productivity growth rates per person fell to 1%, and there was a deficiency between capital accumulation and employment.

Public Debt

On May 1, 2006, the Puerto Rican government faced significant shortages in cash flows, which forced the closure of the local Department of Education and 42 other government agencies. All 1,536 public schools closed, and 95,762 people were furloughed in the first-ever partial shutdown of the government in the island's history.[29] On May 10, 2006, the budget crisis was resolved with a new tax reform agreement, with plans to apply a temporary 1% tax input so that all government employees could return to work. On November 15, 2006 a 5.5% sales tax was implemented. Municipalities have the option of applying a municipal sales tax of 1.5% bringing the total sales tax to 7%.[Source:Puerto Rico Profile

Interestingly enough, Puerto Rico spends a smaller share on education, and a higher share on health and welfare. James Alm’s view on Puerto Rico’s fiscal situation highlights the weak tax administration and the overuse of tax incentives which undermined the government’s attempt of promoting development. Tax revenue in Puerto Rico comes exclusively from three sources: personal income taxes, corporate taxes and to a less extent excise duties. A major problem with having a narrow tax base system means that those left in the tax net face potentially greater distortions of their decision making. Alm’s recommends lowering the corporate taxes and eliminating most of the tax incentives, he further states that incorporation of value added tax would expand the tax base and target consumption.

Solutions to providing more employment

A common theory for low employment and low labour participation rates are the transfer programs involved in Puerto Rico. Authors such as, Maria Enchautegui and Richard Freeman express their views on how, Social Security Disability and Nutritional Assistance programs impedes the economy’s progress by giving large disincentives to Puerto Rican men. Burtless and Sotomayor also further this suggestion, and states that government should link program benefits with incentives to seek employment or to increase the hours of work. [source: The introduction and summary of "The Economy of Puerto Rico"]