Puerto Rico is in economic crisis with $70 billion in debt. On May 2, the island’s Government Development Bank defaulted on most of a $422 million debt payment. The next big payment of $1.9 billion is due on July 1. Puerto Rico is in a total dire situation. As concerns amounted, discussions of whether and how to provide Puerto Rico some relief took place. So far, however, no decision was made on how to help Puerto Rico’s financial crisis.
Puerto Rico’s Governor Alejandro Garcia Padilla believes that Chapter 9 bankruptcy can be a solution because it would allow the island to restructure some of its debts. Under the U.S. constitution, municipalities in U.S. states have access to federal bankruptcy courts to restructure their debt when necessary. However, because Puerto Rico is not a state but a United States “territory,” the island does not have the same level of protections as other U.S. states, including the right to declare bankruptcy. Furthermore, because Puerto Rico is not an independent country, it cannot ask the International Monetary Fund for help.
In fact, Puerto Rico was included in Chapter 9 of the U.S. Bankruptcy Code until 1984, when Congress excluded it from the nationwide approach to resolving municipal insolvency. Critics of extending Puerto Rico bankruptcy rights say Chapter 9 bankruptcy would not fix the root of the problem.
Puerto Rico is in deadlock. In recent years, Puerto Rico’s government has made drastic spending cuts and tax hikes to meet its obligations to creditors. The government laid off tens of thousands of public employees and raised the sales tax from 7 percent to 11.5 percent. It has closed 10 percent of Puerto Rico’s schools since 2014. As the unemployment rises, the younger and more able-bodied workers are leaving the island to the mainland. This, in turn, worsened the economic problem because the government’s spending for public services for those who stay increases as the work-force who pays tax keeps fleeing the island.
What Caused Puerto Rico to Crumble?
Reasons for Puerto Rico’s financial crisis can be traced to institutional factors and malinvestment. The Jones-Shafroth Act (known as Puerto Rican Federal Relations Act of 1917) made all citizens of Puerto Rico U.S. Citizens and reformed the system of government in Puerto Rico. While the law gave Puerto Rico some quasi-independent government, Washington maintained control over fiscal and economic matters.
The law also exempted Puerto Rican bonds from federal, state, and local taxes. The problem was this tax exemption applied regardless of where the bond holder resides. This “triple tax exemption” made Puerto Rican bond extremely attractive to people all over the U.S. to buy these municipal bonds. This provides a huge incentive to the investors from states with high tax rates.
The intent of the Jones Act was to increase investment in Puerto Rico’s economy and create stable infrastructure. With the amendment of the law, business operations in Puerto Rico also received federal tax breaks. Many corporations established their businesses in Puerto Rico to benefit from these tax advantages. However, over time, Congress started phasing out these tax breaks in 1996 and ended them entirely in 2006. With no more tax advantage, businesses began to leave the island.
Furthermore, the changes of the world economy worked against Puerto Rico. Puerto Rico’s minimum wage, which is governed and set by the Federal Labor Standard Act, is high considering Puerto Rican productivity, which is far below mainland levels. Also, the Jones Act required that goods traveling between Puerto Rico and the mainland use U.S. ships, raising transportation costs even further. Relying too heavily on the tax advantages even during hard times, Puerto Rico sold more bonds to pay off its existing debt and to earn more money. However, this created even more debt.
Currently, this amasses to 70 billion dollars. Puerto Rico’s public corporation, such as utilities, hold a significant amount of debt. Default on these debt means that Puerto Rican lose necessities, such as gas, electricity, and schools which is already happening. As the economy continues to deteriorate, more and more people are fleeing Puerto Rico, leaving the burden on a smaller number of people and businesses who cannot handle the situation.
Saving Puerto Rico From Economic Crisis
Puerto Rico is a part of the United States. Whether you like it or not, Puerto Rico’s problem is America’s problem because while Puerto Rico’s government made bad decisions, its economy was inevitably affected by being a part of fiscal union of the U.S. The island’s status as a territory was conveniently used by the mainland, but was not adequately accounted for in the long run, leading to troubled economy.
What do we know about the U.S. territories? Besides the 50 states, the U.S. has several foreign territories. Currently, there are sixteen territories of the United States, five of which are permanently inhabited: Puerto Rico, Guam, Northern Mariana Islands, the U.S. Virgin Islands, and American Samoa. The citizens of the territories are granted U.S. citizenship.
The five inhabited U.S. territories have local voting rights, protections under U.S. courts, and pay some U.S. taxes. They do not, however, have the right to vote in federal elections. Compared to other states, the US territories have limited representation in politics. For example, there is one non-voting member who is elected in Puerto Rico who may vote in a House committee on all legislation presented to the House of Representative.
Basically, these territories are U.S. holdovers from U.S. imperialism. In other words, these territories did not become “territories” by their choice. The fate of these territories varies.
Many territories applied for and were granted statehood. For example, Alaska and Hawaii were once territories, but later became states. Other territories became independent nations. The Philippines were once territory of the U.S. when the islands were ceded by Spain to the United States as a result of the Spanish-American War. The Philippines became an independent country in 1946.
Puerto Rico is America
Puerto Rico is by far the largest US territory, with more people than every other territory combined. It is also physically the closest territory to the United States mainland. Whether the fate of Puerto Rico would change either to a statehood or an independent country is uncertain.
To say the U.S. should deny Puerto Rico the ability to declare bankruptcy or refuse to help restructuring Puerto Rico’s debt is to treat Puerto Rico as if it is not a part of the U.S. but a different country.
Contrary to what many creditors will say, giving Puerto Rico a right to declare bankruptcy will not wash out Puerto Rico’s obligation to pay back its creditors. Chapter 9 bankruptcy is not a bailout, but a debt restructuring plan. Although Congress does not seem to concede and allow Puerto Rico declare bankruptcy, Speaker Paul Ryan is urging and supporting a proposal H.R. 4900, the Puerto Rico Oversight, Management, and Economic Stability Act. In June, the Supreme Court will determine whether the Puerto Rico Recovery Act violates Chapter 9 and whether the island can pass its own restructuring legislation to allow its insolvent public utility companies to restructure their debt.
Remember that one of the primary reasons for the troubled economy is because creditors bought those tax saving municipal bonds without paying tax. Furthermore, hedge funds are making the situation worse by their ruthless pursuit of profit from debtor governments. Considering these causations, the Congress should not drag its feet, but must either come up with a workable solution or allow Puerto Rico to declare bankruptcy.
Authored by Khloe Lee, LegalMatch Legal Writer and Attorney at Law