The Heritage Foundation

Issue Brief #4540 on Puerto Rico

April 1, 2016

April 1, 2016 | Issue Brief on Puerto Rico

Draft House Legislation Falls Short of Priorities for Puerto Rico

Congress should not lose sight of key conservative priorities as it considers whether (and how) to respond to the economic and fiscal crisis in Puerto Rico. The troubled territory has been a laboratory for progressive politics and crony capitalism for decades. Predictably, the government has smothered the private sector, and workers receive a lower share of income in Puerto Rico than in any of the 50 states.[1] Puerto Rico needs to be reformed, not rescued.

A discussion draft recently circulated by the House Committee on Natural Resources contains both good and bad policy ideas.[2] This Issue Brief reviews the draft in the context of conservative priorities and proposes a modest way forward.

Oversight Board

The discussion draft is built around the creation of a powerful Oversight Board, modeled after the District of Columbia Financial Responsibility and Management Assistance Authority, which achieved a notable turnaround for the federal district from 1995 to 2001.

Such a powerful board—with authority to invalidate fiscal acts of Puerto Rico’s legislature and to enact its own—should be considered with caution. Although neither political party in Puerto Rico has shown the capacity to curb the Commonwealth’s bureaucracy or replace its progressive, crony-capitalist economic framework, effectively overruling elected officials should be a last resort.

The current discussion draft gives the Oversight Board enough power to be blamed for failure, but potentially too little power to succeed. Merely balancing its budget will not move Puerto Rico toward sustained growth and might accelerate emigration by increasing tax collection without economic reforms that make it easier to work and do business.

If Congress leaves economic reform to Puerto Rico’s elected legislature, it should also leave budgetary decisions to that body so that the predictable continued decline of the island’s economy can be properly blamed on the relevant decision makers. A half-empowered Oversight Board could be worse than the status quo.

Conservative Priorities

Putting aside the question of whether or not to create an oversight board, Congress should focus on three priorities in considering potential legislation:

1. Offering No Bailouts. The discussion draft does not contemplate any direct bailouts and thus meets this key conservative priority. Congress should continue to stand firm and set a clear precedent that local governments and creditors can expect no financial help from Washington to cover their mistakes. Proposals to increase transfer payments to Puerto Rico are indirect bailouts and ought to be refused as well.

2. Promoting Reforms. The discussion draft instructs the Oversight Board to pursue several vital reforms of public administration. However, it misses most opportunities for economic reform.

  • Good ideas in public administration included in the draft:
    • Requiring current audited financial statements.
    • Requiring more accurate and uniform disclosure of Puerto Rico’s unfunded pension liabilities.
    • Providing a strong budgeting commitment mechanism.
    • Instructing the Oversight Board to help Puerto Rico overhaul its budget process.
  • Additional reforms Congress should consider:
    • Unwinding or privatizing public corporations where possible.
    • Requiring reforms in other areas of public administration, such as by drastically reducing the number of political appointments, enacting civil service reform, de-unionizing Puerto Rico’s public employees, and establishing serious penalties for corruption.
    • Merging the three budgetary institutions of Puerto Rico’s government, which currently share information poorly: the Government Development Bank, the Office of Management and Budget, and the Department of Treasury.
    • Requiring more accurate and uniform disclosure of municipal and state unfunded pension liabilities nationwide as a condition of receiving preferential tax treatment.

On economic reforms, the discussion draft gives the Oversight Board no authority to change non-budgetary laws, and exempts Puerto Rico from only one of the onerous federal requirements that hamper its development.

  • Good ideas included in the draft:
    • Exempting Puerto Rico from the Department of Labor’s overtime rule.
    • Expediting permitting for infrastructure projects.
  • Additional reforms Congress should consider:
    • Exempting all workers (or at least those up to age 30) from the federal minimum wage. Merely extending the training wage in Puerto Rico is a trivial gesture that will not help workers or employers.
    • Exempting Puerto Rico from the job-killing, price-inflating maritime Jones Act.
    • Encouraging fixes to the problems identified in the World Bank’s “Doing Business” and “Paying Taxes” reports.[3]
    • Eliminating lack of English language fluency as a basis for federal disability insurance.
    • Prioritizing reform of economic regulations equally with changes to fiscal laws and policies.

3. Maintaining Legal Continuity. The discussion draft drastically alters legal claims by retroactively applying proceedings substantially equivalent to 11 U.S.C. Chapter 9 bankruptcy to all of Puerto Rico’s debts within the auspices of the Oversight Board. Puerto Rico does appear to lack the resources to make all the payments it has promised, and will thus continue to default on some payments. Congress should not give Puerto Rico extraordinary legal protections from its creditors. Such an unprecedented federal intervention between debtor and creditor could set a dangerous precedent for other troubled state and local governments, and thus severely disrupt the municipal bond market.

There is a legitimate worry that litigation over the 18 different bond classes could take years to settle in courts. An appropriate response for Congress is to offer Puerto Rico and its creditors tools that make it easier to reach an agreement. Neither an Oversight Board nor a future bankruptcy judge, however, should be given the coercive powers of Section 1129(b) of the Bankruptcy Code. Under 1129(b), if a municipality comes to an agreement with one party—such as the pensioners—the rest of the claimants can be forced to accept a default plan in which they had no say.

A far better approach would be to offer creditors the opportunity to vote unanimously to add retroactive collective action clauses to each existing bond indenture. Each class that approved such a clause would strengthen its ability to negotiate with a unified voice, and to accept a deal from the debtor without ever entering bankruptcy court. Such a proposal could help all parties avoid existing legal processes that are expensive and time-consuming.

Moreover, the draft institutes an immediate stay on litigation, effectively stripping creditors of their access to the courts for up to 18 months. During this time, there is nothing to prevent Puerto Rico’s government from defaulting on all its bond payments—about $7 billion—and digging successor governments into an even deeper hole. A stay such as this would set a dangerous precedent and send tremors through the municipal bond market across the United States.

The discussion draft achieves few successes in maintaining legal continuity. It misses the opportunity to improve the negotiating environment and it puts in place “super Chapter 9” bankruptcy proceedings akin to those proposed by the U.S. Treasury Department.

  • Good ideas included in the draft:
    • Requiring consideration of current audited financials before filing a bankruptcy petition.
    • Encouraging negotiation between debtors and creditors.
  • Bad ideas included in the draft:
    • An 18-month stay of litigation that strips a basic civil right from creditors and reduces the government’s incentive to negotiate deals.
    • Imposition of new “super Chapter 9” bankruptcy provisions that can effectively re-write bond contracts without creditor vote or approval.
    • Giving an Oversight Board unilateral authority to waive requirements and initiate bankruptcy proceedings.
    • Allowing, as in Chapter 9, for bankruptcy judges who are not bound, but merely guided, by the relative legal strength of various claims.

A Modest Fix

Congress does not have to solve all of Puerto Rico’s problems, but it can take limited steps that improve economic conditions and promote negotiated restructuring. In a limited approach, Congress could shelve the Oversight Board for the time being and leave bankruptcy law alone.

Modest but potentially successful legislation might consist of the following pieces:

  1. Federal Economic Reforms.
    • Make more accurate and uniform pension disclosure a condition of receiving preferential tax treatment for all municipal bonds so that potential investors know the true liabilities;
    • Allow local control of the minimum wage;
    • Craft exemptions from overtime rules and the maritime Jones Act.
  2. Instructions to Puerto Rico’s Legislature to Enact Some Simple Reforms.
    • Make available audited current financial statements;
    • End privileges that allow some customers free access to public utilities;
    • Enact a civil service law and reduce the number of political appointments to a few hundred.
  3. Negotiation Between Creditors and Debtors.
    • Offer creditors the opportunity to vote to add retroactive collective action clauses to each existing bond indenture.

Such a narrow approach would not solve all of Puerto Rico’s problems, but it would leave legal claims intact and would only limit Puerto Rico’s self-government by requiring basic good-government reforms. Congress can easily attach future financial sanctions to guarantee that the legislature enacts reforms promptly.

Conclusion

Rather than reaching for a high-risk solution to the entire crisis, Congress could focus on taking a few certain steps and following up as necessary. Whatever scope is chosen, though, Congress must avoid bailouts, promote pro-growth economic reforms, and maintain continuity in legal rights.

—Salim Furth, PhD, is Research Fellow in Macroeconomics in the Center for Data Analysis, of the Institute for Economic Freedom and Opportunity, at The Heritage Foundation. Rachel Greszler is Senior Policy Analyst in Economics and Entitlements in the Center for Data Analysis.

About the Author

Salim Furth, Ph.D. Research Fellow, Macroeconomics
Center for Data Analysis

Rachel Greszler Senior Policy Analyst, Economics and Entitlements
Center for Data Analysis

Show references in this report

[1] Salim Furth, “Hired Labor’s Share of Income Is Lowest in Puerto Rico,” Heritage Foundation Issue Brief No. 4502, December 29, 2015, http://www.heritage.org/research/reports/2015/12/hired-labors-share-of-income-is-lowest-in-puerto-rico.

[2] House Committee on Natural Resources, “[Discussion Draft],” March 29, 2016, http://naturalresources.house.gov/uploadedfiles/puertorico_discussion_draft.pdf (accessed March 31, 2016).

[3] World Bank Group, “Ease of Doing Business in Puerto Rico,” Doing Business, 2016, http://www.doingbusiness.org/data/exploreeconomies/puerto-rico/ (accessed March 31, 2016), and World Bank Group, Paying Taxes 2016: The Global Picture, November 19, 2015, http://www.doingbusiness.org/reports/thematic-reports/paying-taxes (accessed March 31, 2016).