To Avoid Becoming The Next Detroit, Puerto Rico Needs Growth, Not Taxes
Posted 02/10/2014 07:08 PM ET
Tax And Spend: Puerto Rico's debt has been cut to junk by two credit rating agencies, prompting an outcry from officials of the recession-hit island that, after all, they've hiked taxes. Well, that's the problem right there.
It's hard to not feel some sympathy for Puerto Rico's new governor, Alejandro Garcia Padilla, who upon entering office last year inherited a hog-wallow of $70 billion in debt, according to a long piece in the weekend's New York Times.
The governor cut spending by 2%, balanced his budget a year ahead of schedule, reformed public pensions and reduced the territory's deficit by 70%.
It wasn't good enough. Moody's cut the island's credit rating two notches to Ba2 late last week, following Standard & Poor's, which cut the municipal rating to BB+ a few days before that.
"Unjust," the governor told the Times Sunday. "I've done everything I can to avoid a downgrade," he said.
However, to make those numbers add up, he hiked taxes on corporations to 39%, far higher than the U.S. rate and well above the Organization of Economic Cooperation and Development average, and let stand a regressive tax on small businesses, giving them a top rate as high as 130%, hitting businesses with the smallest margins, such as groceries, the hardest.
That, plus the phaseout in 2006 of an important tax incentive to U.S. corporations to locate operations tax-free on the island, caused the commonwealth's manufacturing job base to plunge from 160,000 to 75,000, a Detroit-like hollowing out in a very short period.
Combined with public employee unions controlling the electricity supply, forcing companies in a manufacturing-heavy economy to pay double what companies on the U.S. mainland pay, and an increasingly failed educational system — which has kept the workforce uncompetitive (with 90% not meeting the No Child Left Behind standards nor proficient in English) — it's not hard to see why Puerto Rico has an economic growth deficit, which is the root of all its fiscal ills.
This is what Moody's was trying to tell the Puerto Ricans when it cut their debt: "While some economic indicators point to a preliminary stabilization, we do not see evidence of economic growth sufficient to reverse the commonwealth's negative financial trends."
Exactly. There's an old rule of thumb that a state can spend all it likes, but should never allow spending growth to exceed its economic growth. Austerity measures alone won't help in a prolonged recession, because the more critical problem to be tackled is government overspending and entrenched special interests, which are both far harder for politicians to deal with than simply taxing the productive to pay for the mistakes of the nonproductive.
"The new administration has a bookkeeping mentality, as opposed to an economic development mentality," Pedro Pierluisi, the island's non-voting representative to Congress, told the Times.
Too much bureaucracy, much of it for welfare, and too much rewarding failure over success drive up costs and drive out the productive. Puerto Rico's most talented citizens are voting with their feet. The island loses about 1% of its population a year, a deadly loss compounded over the years for any economy.
To bring these people back, the governor has to fight to cut taxes and really go after the country's entrenched special interests with a baseball bat.
The 39% corporate tax has to go.
He also must fight in the U.S. Congress to reinstate Puerto Rico's special tax break that ended in 2006 so that investment will once again return.
Finally, he must also take on Big Labor's favorite, the Jones Act, which artificially drives up shipping costs, putting local manufacturers at a disadvantage, demanding Congress at least give Puerto Rico an exception.
Just balancing the budget on the backs of the productive class won't cut it. The ratings downgrades are a wake-up call to Puerto Rico to fight for real growth — not just a fiscal future a little less like Detroit.