Steps for Fixing Puerto Rico’s Fiscal Problems

Nicholas Johnson
Vice President for State Fiscal Policy, Center on Budget and Policy Priorities

A protestor holds a sign that reads in Spanish: "We didn't take out a loan. We didn't see a dime. We're not going to pay." during a protest in the financial district demanding the island's public debt not be paid to bondholders in San Juan, Puerto Rico, Wednesday, July 15, 2015. Protesters gathered at what is known as The Golden Mile to demand the banking industry take responsibility for the current economic crisis. This month Gov. Alejandro Garcia Padilla said Puerto Rico's outstanding $72 billion public debt is unpayable given the island's long recession. (AP Photo/Ricardo Arduengo)

A protestor holds a sign that reads in Spanish: “We didn’t take out a loan. We didn’t see a dime. We’re not going to pay.” during a protest in the financial district demanding the island’s public debt not be paid to bondholders in San Juan, Puerto Rico, Wednesday, July 15, 2015. Protesters gathered at what is known as The Golden Mile to demand the banking industry take responsibility for the current economic crisis. This month Gov. Alejandro Garcia Padilla said Puerto Rico’s outstanding $72 billion public debt is unpayable given the island’s long recession. (AP Photo/Ricardo Arduengo)

As both parties now agree, the federal government must respond in the coming months to Puerto Rico’s economic and fiscal challenges — most immediately, the $70 billion or so that Puerto Rico owes creditors and on which its government says it must default unless the debt is restructured. Policymakers must address this threat, but they should go further and also implement health and tax policy changes that would prove important pieces of any long-term solution to Puerto Rico’s problems.

Although Puerto Rico’s 3.5 million residents are Americans, they are not represented by voting members of Congress, helping to often make them afterthoughts in congressional debates. But the island’s problems are neither small nor remote. Half a million Puerto Rico children live in families that are poor — more than in 40 states — according to the KidsCount Data Center. Unemployment is 12 percent, more than twice the U.S. rate. Many workers in Puerto Rico either can’t find jobs or work in the underground economy, which means that Puerto Rico’s government collects fewer taxes, contributing to its severe fiscal problems.

The Commonwealth has already made severe cuts in education, human services and other public services. Without a debt restructuring or default, the cuts would have to grow to the point of endangering family well-being and future economic growth. Moreover, these economic and fiscal problems are sending more and more Puerto Ricans to the mainland in search of jobs, placing additional responsibilities on destination states like New York and Florida as they accommodate those newcomers.

As a first step toward solving its problems, Puerto Rico must be allowed to restructure its debt. Otherwise, the Commonwealth will face years of complex and costly litigation over which debts have the highest claims on Puerto Rico’s limited ability to pay, as a recent analysis from Puerto Rico’s premier economic policy institute, the Center for a New Economy, points out.

President Obama is expected to reintroduce, in the 2017 budget proposal that he will unveil today, a plan to allow the island to restructure its debt. House Speaker Ryan has said the House will act on the issue.

But addressing the immediate debt crisis and default threat should be the start, not the end, of federal attention to Puerto Rico’s problems. The federal government should treat Puerto Rico more equitably under various programs. For example, as my colleague Edwin Park has noted, the federal government provides only a fixed amount of federal Medicaid funding to Puerto Rico and leaves the Commonwealth responsible for all costs above the cap. As a result, the federal government effectively picks up a dramatically smaller share of Medicaid’s costs in Puerto Rico than in the states — just 15 to 20 percent of the Commonwealth’s Medicaid costs, compared with an average of 57 percent for the states. In fact, if Puerto Rico were treated the same as a state — i.e., under the federal formula that determines the federal Medicaid matching rate for each state — the rate for Puerto Rico would be 83 percent.

These federal Medicaid funding shortfalls contribute to Puerto Rico’s troubled fiscal situation. The island’s residents heavily rely on Medicaid; 40 percent of them were enrolled in Medicaid in 2014. This puts a heavy burden on the Commonwealth’s finances. Although health reform provided a one-time boost in federal Medicaid funding to help address these shortfalls, Puerto Rico is expected to exhaust those funds as early as next year.

Similarly, extending the Earned Income Tax Credit (EITC) to Puerto Rico’s working families could reduce the twin crises of child poverty and low participation in the above-ground workforce. Senate Finance Committee Chairman Orrin Hatch has called for “tax incentives . . . [to] incentivize growth and labor force participation” in Puerto Rico. The EITC is such a tax incentive; as extensive research has found, it strongly encourages workforce participation while also fighting poverty and boosting children’s long-term educational attainment and earnings.

This post originally appeared on Off the Charts, the Center on Budget and Policy Priorities’ blog.

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