How can Puerto Rico break its debt spiral?

A task force charged with addressing Puerto Rico’s fiscal emergency unveiled a plan Wednesday that would significantly cut government benefits and increase taxes, while calling on creditors to restructure a large chunk of the island’s nearly $73 billion in outstanding debt.

The reform plan proposed by a working group established earlier this summer by Puerto Rico Gov. Alejandro Garcia Padilla said the island faces a budget deficit of $28 billion over the next five years alone. More immediately, the island’s treasury and its central bank both are on course to run out of cash by next June, underscoring the urgency to strike debt deals with creditors and implement reforms.

The task force proposed closing the budget gap and revitalizing the island’s stagnant economy by tightening welfare benefits, exempting young workers from future minimum wage increases, privatizing government assets, tightening tax enforcement and having the island exempted from regulations that increase the price of fuel used to generate electrical power.

Those far-reaching reforms–which would come after years of austerity that saw government jobs and pensions slashed and taxes increased–would be overseen by a five-person financial control board whose members would include candidates nominated by creditors and, possibly, the federal government, task force officials said in a telephone briefing for reporters.

Even if Puerto Rico lawmakers approve all of the proposed reform measures—which is far from certain—the government would have to renegotiate about $18 billion in loan payments that come due over the next five years. Much of that debt is held by hedge funds that have scooped up the loans at discounted rates as the island’s economy has teetered over the past decade. But a lot of it is also held by retail investors in Puerto Rico and on the U.S. mainland, who were attracted by their exemption from local, state and federal taxes. In the case of the island’s general obligation bonds, there is a constitutional guarantee of repayment that likely gave solace to investors even as the island’s economy has languished in recession and its debts mounted.

Task force officials said that those old promises are no longer viable, given the island’s fiscal crunch. There is simply not enough money to prioritize creditors, and the pain of restructuring would have to be borne by all of them if Puerto Rico is to have a shot at a getting through the fiscal crisis without more serious damage. Negotiations with creditors of the island’s electrical utility already have yielded a restructuring deal for part of its debt. Officials said other creditors are expected to enter restructuring discussions in the coming weeks, although there is no guarantee that a deal can be reached.

“The massive public debt of Puerto Rico is an impediment to growth,” Garcia Padilla said in a televised speech on Wednesday. “It is time for the creditors to come to the table and share the burden of the sacrifices.”

Officials emphasized that the pain would also be shared by ordinary Puerto Ricans as well as businesses on the island. With just two out of five working-age Puerto Ricans in the labor force, and many others fleeing to the mainland, the task force has proposed suspending any future minimum-wage increases for workers under age 25. It also has proposed lowering nominal tax rates for corporations, while closing the gaping loopholes that allow many firms to avoid them. At the same time, the group said, a corporate excise tax due to be phased out in two years should be extended.

It also recommended that the island privatize ports, roads, and bridges to raise revenue and offload capital costs. Meanwhile, the plan calls for schools to be closed, and funds that go to the University of Puerto Rico and local governments to be reduced.

Meanwhile, the island should ask Congress to remove caps on Medicaid funding, increase Medicare reimbursement rates, and exempt Puerto Rico from the Jones Act, which requires all cargo shipped form the mainland to the island to be done on U.S.-flagged ships, increasing transportation costs.

In addition, the island is continuing to press for Congress to allow its local governments and public corporations to reorganize their debts in bankruptcy—and idea endorsed by the Obama administration and some lawmakers. But others in Congress oppose that remedy, which they liken to a bailout.

A plan should be implemented quickly to “avoid a disorderly default on the Commonwealth’s debt and a legal morass that will further destabilize the economy and public finances,” according to an executive summary of the task force plan. “The long-term fiscal and economic stability of Puerto Rico is dependent upon the willingness and sacrifices of all involved to restore the island’s economic growth.”

This article is published in collaboration with Wonk Blog. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Michael A. Fletcher is a national economics correspondent for the Washington Post. 

Image: A participant holds a flag during Puerto Rican Day Parade in New York June 14, 2009. REUTERS/Eric Thayer