The Honorable Tom Marino, Chairman
The Honorable Blake Farenthold, Vice Chairman
The Honorable Hank Johnson, Ranking Member
Subcommittee on Regulatory Reform, Commercial and Antitrust Law
Committee on the Judiciary
U.S. House of Representatives
2138 Rayburn House Office Building
Washington, DC 20515
Dear Mr. Chairman, Mr. Vice Chairman, Mr. Ranking Member, and Members of the Subcommittee:
On behalf of National Taxpayers Union’s (NTU’s) members across the nation, including those who reside in the Commonwealth of Puerto Rico, I write to provide comments regarding today’s hearing on proposed legislation to make Puerto Rico’s public corporations and municipalities eligible for debtor status under Chapter 9 of the Bankruptcy Code. Besides the legislation immediately before the Committee, H.R. 870, there are a host of issues surrounding Puerto Rico’s fiscal future that merit deliberation. Taxpayers are grateful that you are focusing on these urgent matters.
For many years, NTU has been concerned over the implications of the Commonwealth’s tax, expenditure, and borrowing policies, for the territory itself and for the United States at large. For example, as proposals were being debated in 2010 to restructure Puerto Rico’s tax system, NTU cautioned that despite some laudable progress toward reducing certain tax rates, the imposition of other problematic levies could lead to “less revenue than anticipated and more structural deficit headaches for public officials, but just as important, fewer economic opportunities.” NTU likewise contended that with a greater focus on limiting the size of its government’s fiscal reach, “Puerto Rico’s leaders can escape a harsh sentence that could otherwise confine their people to poor economic conditions for years.”
Our observations at the time were hardly gifted insight; rather, they were informed by decades of experience on the part of governments across the United States and around the world. Yet, sadly, the evidence and lessons were not sufficiently heeded. It now appears that the Commonwealth of Puerto Rico, a U.S. territory, may be insolvent for all intents and purposes. Even those who may disagree with such an assessment would surely admit that the Commonwealth is on the brink of this sad state. Accordingly, we urge Members of this subcommittee, and the full House Judiciary Committee, to seriously consider a more long-term, comprehensive approach to Puerto Rico’s debt that can include a variety of steps.
Decades of spending too much, promising even more, dysfunctional (and on occasion corrupt) governance, arbitrary tax collection procedures, and other factors made Puerto Rico particularly vulnerable to the headwinds of the Great Recession. The Commonwealth is now in dire straits. Pensions are underfunded and dozens of factories have closed. Even with the exodus of over 200,000 of its 3.7 million people, the unemployment rate is above 13 percent. This emigration of talent will hinder the island’s future economic potential.
The roughly $70 billion in debt Puerto Rico has floated now approaches 70 percent of its Gross Domestic Product, and shows few signs of receding. The unfunded liabilities in pension and health care benefits, along with projected budget deficits, makes this picture even worse. By some estimates, the current amount owed is four times that incurred by Detroit in its landmark municipal bankruptcy in 2013.
Amid growing uncertainty on how to pay bondholders, major credit rating agencies last summer downgraded to junk status the bonds intended to undertake investment in schools, infrastructure, and other public projects. Though the U.S. federal government – and some state governments – have been rightly criticized for poor stewardship over their debts and have suffered downgrades, Puerto Rico is in a more dangerous condition as far as its credit rating is concerned. Only a few U.S. localities can be said to have shared such ignominy.
But just as Detroit’s demise prompted some (largely muted) calls for a federal bailout, Congress’s immediate problem today is that the looming prospect of the insolvency of a U.S. territory raises obvious questions about whether U.S. taxpayers will be asked to shoulder some of the debt burden. An added pressure is the broader political and economic effect that insolvency could have in the Caribbean and the Americas.
However, we also urge lawmakers to keep in mind another factor: many Americans have a personal financial stake in Puerto Rico’s solvency, stability, and growth. The primary reason is that major U.S. firms have invested in Puerto Rican bonds because of their exemption from federal, state, and local income taxes. This triple tax exemption has made them a popular option for mutual fund managers, who have invested the retirement savings of millions of Americans in Puerto Rican bonds.
A climate of uncertainty for investors and businesses is no idle concern. As Dan Barrett, my colleague at NTU’s research arm, recently put it in an analysis appearing online:
[I]f residents don’t know what to expect in the future, they will prepare for the worst the best they can. This means that firms might not expand because they are not sure if they will get a return on their investment. Why hire additional staff or expand the factory if you can’t expect the economy to grow? Entrepreneurs will also try to mitigate their risk by not opening new businesses, even though they may see a market opportunity. More broadly … taxpayers may … divest themselves of traditional financial tools like municipal bonds because they refuse to receive marginal or negative returns. With these groups simultaneously acting to protect their assets and dollars, the economy could plunge into freefall.
The downward spiral has to stop. Given the depth and breadth of Puerto Rico’s plight, we believe it would be useful for Congress to look even beyond the issue of allowing Puerto Rico’s public corporations and municipalities to use Chapter 9’s debt-restructuring procedures. A more comprehensive review of what led up to the crisis and a far-reaching plan to attack systemic dysfunction might help prevent a recurrence. For instance, such a review could reconsider the Jones Act, which effectively requires only U.S. ships to carry goods between U.S. ports despite Puerto Rico’s proximity to other Caribbean countries. The result has been higher costs for Puerto Rico’s businesses. NTU has long called for complete repeal of the Jones Act, not only for the sake of Puerto Rico but also for state governments, including Alaska and Hawaii.
A wider and deeper probe could identify ways to reduce high regulatory costs and introduce greater uniformity in the administration of sales and use taxes. Currently, more than 40 percent of such taxes are not collected, leading to a lack of confidence and predictability in the tax system itself. Chapter 9’s narrow authority could very well leave these and other endemic maladies unchanged.
The Commonwealth should also consider strengthening some of the advantages of its public finance system. Puerto Rico’s constitutional balanced budget requirement, which is too dependent on gubernatorial discretion, could be more effective if it were properly tightened. The Commonwealth’s salutary policy toward taxation of capital gains is another cornerstone upon which to build a sound policy for attracting investment.
Federal oversight is another option. This was the approach taken by Congress for the District of Columbia 20 years ago. The District’s financial control board contained the debt, ensured pensions were sustained and bond payments were made, and at least helped to address the mismanagement that plagued the nation’s capital. This enabled the city to once again attract bond financing and private investment. The action taken to introduce reform to the District of Columbia, with its unique political status, provides a useful precedent of how Congress may be able to assist territories in financial peril.
Puerto Rico’s dire situation presents this subcommittee and the full Judiciary Committee with an opportunity to send a message: government entities should no longer assume they can spend recklessly and abuse the public trust. Taxpayer-funded bailouts or bankruptcy proceedings that shortchange bondholders and citizen investors alike cannot be regarded as “easy outs”. Taxpayers and investors have the right to insist on better stewardship of their money and more honesty from elected officials to avoid debt emergencies in the first place.
If Congress takes the significant step of extending Chapter 9 to Puerto Rico’s public corporations and municipal entities but ignores the need for broader restructuring, it will miss an opportunity to bolster the rule of law and effective governance in Puerto Rico and beyond. NTU is committed to assisting lawmakers in achieving the latter ends.
Thank you for the opportunity to provide these comments, and NTU is at your service should you have any questions or require any assistance
Sincerely,
Pete Sepp
President