For Puerto Rico, There Is A Better Way – A Second Look at the Commonwealth’s Finances and Options Going Forward by Centennial Group

Authored by Jose Fajgenbaum, Jorge Guzman, and Claudio Loser

Executive summary

Puerto Rico can avoid a costly default even after consideration of the Krueger Report (the “Report”)

  • Puerto Rico has a deficit problem, not a debt problem
  • Deficit is fixable and extensive history exists of other governments that made similar or greater fiscal adjustments and subsequently grew their economies
  • Path laid out by the Governor has significant risks and is not the answer to Puerto Rico’s deficit problem
    -Ignores legal limitations and the priority granted to GO and Commonwealth guaranteed debt by the Puerto Rico Constitution
    -Ignores large and long lasting economic costs
    -Ignores significant costs to on-island retail and institutional investors who hold substantial amounts of the Commonwealth’s obligations
  • Puerto Rico has ~18 different debt issuing entities that make up the $72 billion of outstanding debt. Each entity has its own legal particularities and financial capacities and thus each should be considered individually

Puerto Rico government has begun to make a fiscal adjustment

Puerto Rico’s true deficit has been shrinking

  • Deficit estimated to be only 1.3% of GNP in FY2015

Puerto Rico

Krueger Report shows path forward without need for a default

Report demonstrates the ability of Puerto Rico to generate a growing surplus

  • Report suggests several measures for both fiscal and structural reform
  • Fiscal reform measures

-Revenue increases of $3 billion per year by 2020, $4 billion per year by 2025

-Adoption of increased SUT

-Income tax surcharge on corporations receiving exemptions, eventual move to flat rate

-Step up in property taxes (real property values were last assessed in 1958)

-Increased individual income taxes from higher labor participation

-Expense cuts of $2 billion per year by 2020, $2.5 billion by 2025

-Freeze formula-based General Fund appropriations

-Reduce number of teachers to fit the size of the student population

-Reduce subsidy to University of Puerto Rico

-Cut excess Medicaid benefits

  • Structural reform measures

-Amend local labor laws regarding overtime, vacation time, mandatory bonuses, and others

-Make welfare benefits consistent with local labor market condition

-Reduce transportation costs by seeking Jones Act exemption

-Reduce energy costs via PREPA reform

-Modernize / improve processes to facilitate new business startups in Puerto Rico

-Specifically, property registrations, new business permits and tax collections

Report includes reform measures that can lead the Commonwealth to fiscal surpluses

  • Below chart shows central government overall balance after including revenue and expenditure reforms and the GNP effects of such reform as included in the Report
    -Assumes status quo with respect to ACA and Act 154
  • Financing should be utilized to provide bridge to implement reform measures

Puerto Rico

Puerto Rico has room to increase revenues

Puerto Rico’s federal and state tax collections are low compared to US states

  • Commonwealth has opportunity to increase revenue while maintaining tax levels inline with the US states
  • Below chart shows state and federal taxes as a percent of GDP for the US states, Puerto Rico is shown both as a percent of GNP and GDP

Puerto Rico

Improve tax collection rates

  • Estimated that Puerto Rico sales tax compliance is 56%  compared with an average of 83% in the 50 states
  • Extrapolation would suggest an incremental $1.1 billion available if Puerto Rico sales tax collection rates could be improved to the 50 state average
    -Sales tax is only a small part of the broader tax collections
  • An increase in compliance rates would provide additional revenue to the government without increasing the burden on the existing tax base
  • Increased fiscal flexibility associated with improved tax compliance can be used to facilitate further GNP growth in the medium-term

Puerto Rico has room to lower expenses

Total governmental expenditures increased 29% or $4.4 billion in the past decade while population declined 6%

  • Government expenditures have not been adjusted to reflect Commonwealth’s current situation

Puerto Rico

See full PDF below.