Puerto Rico Still Doesn’t Get What Makes An Economy Tick

Originally published by Fox News here.

In a recent FNL opinion piece, Puerto Rico’s Governor lauded his own administration’s efforts to jumpstart the island’s “recovering economy.” Yet, since taking office in 2013, Puerto Rico continues to make headlines for its fiscal mismanagement, poor economic performance, and most recently for the credit rating smack-down given by all three major credit-rating agencies, leaving many to wonder: “What recovery?”

To be fair, the Governor should be given some credit for his recent efforts to appease creditors.  It can’t be easy to manage a deficit-laden government with the perpetual looming threat from lenders to make it harder to borrow money. His oft-touted “Jobs Now Act of 2013,” combined with pension and utility reforms, show a marked interest in changing the economy. The $300 million-plus revenue increase in fiscal year 2014 makes it seem as though Puerto Rico might even be making some headway towards slowing the island’s downward-trending credit ratings and overall fiscal crisis.

But, a closer inspection reveals that — despite the best of intentions — the new policies may not be the best reforms for long-term economic development.

The Jobs Now Act provided a number of tax exemptions and credits, along with an extra incentive to hire such underemployed groups as former government workers, older women, and younger workers. Unfortunately, the latest policy research has proven such hiring credits to be mostly ineffective. In fact, the state of Maryland recently allowed its hiring credits to expire, instead emphasizing more effective jobs training programs that target specific sectors. The cost to hire and train new employees can add up to as much as a full year’s salary, which is why a few thousand bucks provide little motivation.  Knowing this, I was surprised to hear the Governor attribute the recent creation of “over 30,000 jobs” to his Jobs Act.

It’s especially surprising given the latest employment numbers. According to the Government Development Bank of Puerto Rico, employment trends have yet to improve. While unemployment actually fell by a full percentage point in 2012, it completely reversed this trend in the first year of this administration, climbing from 14.6 percent to 15.4 percent by December. The budget for fiscal year 2013, which corresponded with a fall in unemployment to 13.5 percent, was created before the current governor was in office, while 11,000 unemployed persons were added during the subsequent fiscal year 2014 budget period, increasing the rate to 15.4 percent (nearly double that of the fiscally-inept Illinois).

If 30,000 jobs were created, they were dwarfed by a far greater number of job losses. The governor’s pension reforms were on the right track. It’s unfortunate that the Supreme Court of Puerto Rico is stalling their implementation, effectively limiting his fiscal authority. But, even if reforms are allowed to proceed, they need to be on a grander scale, regardless of the political backlash from voters. In a fiscal crisis, with a very real possibility of everyone on the government payroll being left with their hands out, Puerto Rico has no choice but to shift the burden of retirement from the average taxpayer to the relative handful of government employees.

The same mentality should dominate out-of-control utility costs. Like so many municipalities before it, Puerto Rico has proven itself to be a maladroit administrator of its state-owned utilities. In one case, poor management has resulted in energy prices that are nearly twice the cost of anywhere else in the U.S. Some minor reforms have reportedly helped reduce costs, but again, drastic reforms such as privatization, increased competition, and greater diversification are needed.

Fiscal year 2014 revenues to the Treasury are higher than the previous year at this time (even though still not even as high as they were at the end of FY13), but the source of those revenues is my biggest concern. Individuals and small business owners were gifted an income tax increase of up to 20 percent in 2013, while corporate taxpayers are paying 30-60 percent more than they did before.

Corporate tax increases are an easy way to bolster revenues without affecting individuals — at least that’s what politicians want you to think.  The seemingly counter-intuitive reality is that businesses don’t pay taxes. When taxes on these entities rise, the added costs are passed on to its employees and/or consumers. This simple economic principle is often misunderstood by too many elected officials (perhaps because most of them have never run a business).

Combined with new sales and use taxes on many services, and your average Puerto Rican is the one bearing the brunt of the new government’s fiscal hammer.

These shifting costs, combined with an increasing disincentive to expand businesses in Puerto Rico, may help to explain why the Government Development Bank’s Economic Activity Index shows a 5-6 percent economic downturn over the previous fiscal year.

And they wonder why Fitch, S&P, Moody’s, and numerous others are concerned that Puerto Rico won’t be able to pay its bills?

Even if they are finally able to balance their budget, the governor is going to have to push beyond his political limits to focus on incentives for growing businesses in Puerto Rico, such as rolling back the higher tax rates, expanding the incentive for foreign investment, and explicitly targeting companies in high-growth industries for residency in Puerto Rico.

Puerto Rico needs its fiscal administrators to realize that the greater problem isn’t its credit rating and short-term debt, but the underlying structural economic problems that drive innovation, business growth, and employment for the citizens, and future taxpayers, of Puerto Rico.