The plan to aid Puerto Rico falls short

Last week, the Obama Administration unveiled a far-reaching roadmap for Congress to aid the beleaguered island territory of Puerto Rico. The plan incorporated some of the best ideas floated by think tanks, independent agencies, and government task forces since the island started losing people and jobs a decade ago with the final phase-out of tax subsidies for US multinational firms located there.

However, by not specifying a price tag for the plan and a way to pay for it, the Administration may have missed an opportunity to avoid a messy default and put the island on more sound economic footing.

What would the plan do? First, it would redress what some have called a drafting error in the US bankruptcy code that bars territories – but not states – from allowing their municipalities and public corporations to enter bankruptcy. Bills introduced in the House and Senate would similarly grant this power. However, the Administration plan would go even further, effectively treating the whole territory as a municipality and granting it access to “super Chapter 9.”

The plan would also create an as yet unspecified mechanism for independent financial oversight, a key step forward. As I’ve previously written, Puerto Rico’s own proposal for an internal control board was destined to fail. The only way that jurisdictions as diverse as New York City, the District of Columbia, Miami, and Cleveland have overcome severe fiscal challenges was through externally appointed control boards, emergency managers, or financial overseers.

The next steps are a little murkier. The Administration would treat Puerto Rico more like a state when it comes to Medicaid. This would mean increasing the rate at which the federal government reimburses the island for its Medicaid expenses and eliminating the current cap on federal payments, resulting in another $1 to $2 billion in annual transfers to Puerto Rico according to the GAO.

In addition, the plan would extend the federal earned income tax credit (EITC) and child tax credit (CTC) to Puerto Rican residents. This step could help address Puerto Rico’s low labor force participation rate. However, it could also cost the federal treasury up to $6 billion over ten years unless accompanied by greater tax liability for people living in Puerto Rico, who currently – despite being American citizens—do not owe federal income taxes (although they do pay payroll taxes).

So what’s next? If Congress fails to act, Treasury will continue to provide technical assistance, which is no small feat given the Commonwealth’s out of date information systems. (The Commonwealth has not filed audited financial statements since 2013, although it has released some very dire bond offering statements.)

Perhaps there will also be action on another proposal floated two weeks ago for Treasury to help the territory collect taxes and direct bond payments to investors, who may appreciate the added security enough to accept new bonds at a lower interest rate or other restructuring. However, given a complicated history and upcoming gubernatorial elections, few Puerto Ricans would welcome Uncle Sam as tax collector and financial guardian.

Puerto Rico can emerge from this fiscal and economic crisis. The island has many inherent strengths – and some weaknesses – stemming from its unique relationship to the United States (Figure 1). However, Puerto Rico will need help getting through the next few months. It will need sustained support building local capacity for economic development, quality public services, and the like. Private foundations and educational institutions should play a role, as they have in other distressed US states and cities. But, in the end and as in many other troubled jurisdictions, the federal government will need to step up.

This article first appeared at TaxVox.