Executive Summary 

• Puerto Rico now has a real chance for economic recovery. Last January the Financial Oversight Board for Puerto Rico closed an almost five year-long bankruptcy case with 80% of the islands outstanding payments reduced. 
• Set up in 2016, The Financial Oversight Board is a federally appointed group with limited powers over Puerto Rican finances tasked with guiding the Commonwealth out of its financial crisis. 
• However, there are signs that point to the possibility of Puerto Rico falling into the same political and financial pitfalls that originally caused the crisis in 2007. 
• The process to a better Puerto Rico is not going to be a gentle one, and the Federal Government on the mainland must be willing to back up the Oversight Board and resist populist temptations if the island is to have a more prosperous future. 

Introduction 

Last month the Commonwealth of Puerto Rico reached a milestone in its financial crisis. The Congressionally created Financial Oversight Management Board completed one of its main objectives by reducing the island’s financial obligations. With an overall 80% of outstanding payments reduced through a special bankruptcy proceeding, the debt has now been brought to a more manageable amount of roughly $33 billion from the previous $72 billion. This means Puerto Rico has an unprecedented opportunity to reform its oversized and overspent government into a leaner, smarter institution. 

In order to make the remaining payments and ensure the island returns with a more efficient bureaucracy, the Oversight Board has suggested a series of austerity measures for the Commonwealth. Unsurprisingly, cutting government staff, wages, and spending is a hard political sell on an island where more than 40% of the population lives below the poverty line. Protests have erupted with teachers and other public employees demanding higher wages, as well as past protests by students over subsidy cuts to the University of Puerto Rico. 

However, all economic indicators point to these austerity measures being necessary, and the Commonwealth cannot afford to be left to adopt its old spending habits. Past Puerto Rican politicians refused to cut the island’s massive social spending out of fear of losing elections, instead they sold more debt to cover the costs and pacify constituents. This pattern cannot be allowed to repeat itself. The Oversight Board has struggled with four governors for about six years on this very issue, nullifying laws and denying budgets which fell into the old habits of overspending. While much of the task is left to the begrudging Commonwealth, we here on the mainland should be sure to not to give into populist resistance against the austerity measures of the Board, or Puerto Rican bankruptcy might not be a one-time phenomenon. 

Spending Deficit 

Prior to 2016, Puerto Rico had many government-funded social services. Electricity was provided free of charge to municipalities though the Puerto Rican Electric Power Authority (PREPA). The government also provided subsidies to the University of Puerto Rico’s eleven semi-autonomous campuses to keep costs low for students, and pensions for those who worked in the government were generous. The Commonwealth even gave out a yearly “Christmas bonus” to its employees and required private employers to do the same. Additionally, government services were often mismanaged. PREPA refused to replace its expensive petroleum powered plants with more cost-efficient options, and municipalities that received free electricity spent the savings on publicly owned hotels, restaurants and ice rinks. The eleven semi-autonomous campuses of the University increased costs and ran a deficit due to requiring more administrative management. The island also lacked a central monetary tracking authority and staffed an oversized bureaucracy which allowed corruption and financial blunders to go unnoticed.  

This overspending and mismanagement were fiscally covered when the island had business investments. But after President Bill Clinton set special federal income tax breaks for businesses on the island to expire after 10 years in 1996, companies started to lose any incentive to stay. The tax system of the Commonwealth also had high rates for a select few businesses as reported by the New York Federal Reserve in 2014. These high rates scared off the businesses taxed with them, and the narrow base left the Commonwealth without alternative sources of revenue. The business exodus caused economic growth to slow, and the recission in 2007 placed immense strain on the Commonwealth. In the end, the government found itself with plenty of overpriced bills and no income. 

The Oversight Board and The Commonwealth 

To solve the problem, Congress passed the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA, in 2016. PROMESA established an oversight board similar to the one which was tasked with aiding the bankrupt District of Columbia from 1995 to 2001. Unlike the D.C. Board, the Puerto Rican Board does not have the ability to directly override the decisions of the Commonwealth government. As noted by Judge Laura Swain in a lawsuit between the Commonwealth and the Board, PROMESA establishes “an awkward power-sharing arrangement” between the Commonwealth and the Board. The Board can approve fiscal policies and budgets, but must allow the legislative process to implement them. The Board can, and has, successfully sued to nullify laws contrary to its approved fiscal plans, but this process is usually one of last resort. 

Thus, the Board and the Commonwealth have clashed on more than one occasion. Board members have the luxury of being federal appointees who are isolated from the political ramifications of their proposed austerity measures and nullified laws. Puerto Rican politicians are afforded no such luxury. When The Board demanded the elimination of the traditional public employee “Christmas Bonus” to cut costs, or a freeze on unpayable pensions, the politicians pushed back to pacify their voters. Puerto Rican politicians are tired of having their legislation live at the will of the Board, and the Board is frustrated with the lack of political will to implement their policies.  

The Unpopular Option 

Protests against the Board have now reached Washington. Populists such as Rep. Alexandria Ocasio-Cortez have suggested a complete erasure of Puerto Rico’s debt and the abolishment of the non-elected Oversight Board. Her claims to the latter are seemingly backed by Commonwealth Gov. Pedro Pierluisi in a quote to The Hill on February 2^nd stating, “No question that we will not be facing any significant fiscal challenges in the future” hinting that the job the Board was sent to do was finished. The Biden campaign proposed to fix Puerto Rico with federal funds and programs, as well as end the Board’s austerity programs. The Biden Administration acted on part of this promise in November when they granted the Commonwealth some extra Medicaid funds, a move which caught the ire of the Government Accountability Office. However, these more popular options will cause more harm than good. 

To start, abolishing the debt might provide short-term relief to the island, but will damage their long-term lending reputation. The ability to issue debt is important for any government, and the Commonwealth might find themselves without customers if they signal their willingness to cancel financial obligations unilaterally. Debt is also not Puerto Rico’s sole spending ill. For example, subtracting long term debt payments from the University of Puerto Rico’s 2015 budget still leaves them with a $1 billion deficit. Secondly, the notion that the island will not face any more fiscal challenges is mistaken at best. True, the Commonwealth has seen the unemployment rate decrease from 12.2 in 2015 to 7.5 today, and the poverty rate drop from 46.1% to 43.5% over the same time. But an unemployment rate over California’s 6.5, and a poverty rate over twice as high as Mississippi’s hardly implies a lack of “significant fiscal challenges,” or suggests that the Board and the Commonwealth have finished their task. 

Lastly, federal funds are not a sustainable way to run a government. The Commonwealth was notable in its funding of Puerto Rico’s wide range of social services and amenities. When the Commonwealth ran out of cash to subsidize their spendings, they issued debt. To subsidize the Commonwealth with federal money will only put the island’s economy on another form of monetary life support rather than fixing the spending issue. Additionally, if the Federal Government ever found itself in financial trouble, or stopped sending funds to the Commonwealth, the island’s economy could become fragile as it did after the Clinton Administration repealed their special tax treatment. 

While there is little evidence for the popular options, there is early evidence for the effectiveness of the unpopular austerity measures. For example, prior to their first Board-approved budget for Fiscal Year 2019, the University of Puerto Rico ran an over $1.3 billion dollar deficit each year from FY2015–FY2018. After the Board approved fiscal plan was implemented, the University managed to budget a surplus of $15 million in FY2019. The University did face deficits of $84 million in FY2020 and $32 million in FY2021, but both were shadows of the former 10-figure deficits and were due to earthquakes and an unprecedented pandemic. PREPA has also started to benefit from austerity measures. The agency declared bankruptcy in 2017 with a debt of $9 billion and ran an operating expense of over 3.3 billion dollars in 2018. With the austerity recommended sale and transition of the grid to the private company LUMA in 2021, PREPA was able to run a $3.1 billion budget and earn a $6 million surplus. 

While harsh, the fiscally sound way to save Puerto Rico is to cut spending while also creating a leaner and more efficient government friendly to enterprise. Balanced check books might be hard to sell and tough in transition, but breaking even financially is a sound way to build an economy. The old Puerto Rican economy was built on special federal tax breaks and debt and fell without both. The new Puerto Rico must be one that can successfully operate without special treatment from Washington. If the mainland is to help the Commonwealth, the best course is to encourage Puerto Rican officials to work with the Board on the unpopular task of bending the Puerto Rican economy into shape.