US plan for Puerto Rico isn't good enough

Puerto Rico, facing a serious debt crisis, has asked for and deserves help from the U.S. government.The commonwealth is a U.S. territory and its residents are United States citizens. Puerto Rico has seen real output plummet since 2005, and forecasts anticipate essentially stagnant territorial income for the next decade. Unemployment there is expected to average nearly 13 percent over the next 10 years. Puerto Rico is suffering the loss of population and declining labor-force participation.

The Obama administration's recently announced plan to address the fiscal crisis is not going to cut it.

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A pedestrian walks past a building painted with graffiti in San Juan last June.

In essence, it consists of a broad new bankruptcy regime, increased Medicaid spending, a "tax credit" for labor supply, and a financial control board. The most prominent policy debate to date has been the possibility of providing Chapter 9 bankruptcy protection for governmental-owned entities; the administration expanded this idea to include the government itself. It is always dicey to change the rules midstream. Moreover, bankruptcy would not increase economic growth or alter the fundamental fiscal trajectory. There may be a place for bankruptcy protection of some sort, but this idea should be at the end of the line; not the front.

Similarly, there is nothing about increased Medicaid spending that will help the economy or budget problems. It may be the case that superior health policy would involve more federal dollars, but that is an issue separate from the fiscal crisis.

The administration argues that Puerto Ricans should be allowed access to the Earned Income Tax Credit. The EITC has been successful in raising labor supply – particularly among single mothers – but it is odd to argue that the island's workers should receive a federal income tax credit when they do not pay the income tax. This is a proposal to pay the Puerto Ricans to work, an outcome that is better generated by broader economic reforms.

Forget bankruptcy, this is how to fix Puerto Rico

The financial control board sounds good in principle – such boards were involved in New York and Washington DC – but it is hard to imagine a board that simultaneously respects the sovereignty of Puerto Rico and has sufficient political independence to be successful.

Substantively, the starting point for a real solution is to make clear the size and scope of the problem. Unfortunately, confusion reigns on this subject. Though we are told that a 2014 financial statement is forthcoming, Puerto Rico does not currently have audited financial statements for the past two years. This makes it difficult, at best, to generate a comprehensive projection of the evolution of the liabilities of the 17 debt-issuing entities. Creditors hold a variety of beliefs on the fiscal problem, ranging from no problem to a liquidity issue to serious insolvency. A simple solution would be for the U.S. and Puerto Rico to agree to have the International Monetary Fund use its expertise in sovereign debt problems to establish a single set of facts.

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Having done so, the key to altering Puerto Rico's budget trajectory is to improve the outlook for growth, employment, and income. The bulk of the needed structural reforms must be undertaken by Puerto Rico. Reforms should bring its labor market practices into closer alignment with the rest of the United States. Puerto Rico should reduce regulatory impediments and other burdens on business. It should consider privatization of major public sector corporations and improved government efficiency. In some municipalities, 98 percent of budgets are payrolls, which suggests that these entities could be consolidated without diminishing services.

Puerto Rico has undertaken important pension reforms in the past several years, but with public pension liabilities of $43.5 billion, this area of commonwealth finance must also be further reformed. While additional tax collection should be part of Puerto Rico's budget reforms, it should not reflect the bulk of the solution, which must be found among the key drivers of the commonwealth's debt.

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Federal policy makers can be helpful as well. A start would be to exempt Puerto Rico from the federal minimum wage and the Jones Act. The ratio of the minimum wage to the median wage in Puerto Rico is 77 percent, the highest of any state or territory. The next highest (South Dakota and Guam) is 59 percent, which would require a minimum wage of $5.55 in Puerto Rico. Lowering the minimum wage to put Puerto Rico in the middle of the rankings of states and territories would require a minimum wage of $4.50. The minimum wage is simply too high for Puerto Rico.

Politically the plan falls short as well. The administration has simply not put in the effort and laid the groundwork for rapid action on Capitol Hill. Calling on Congress to act quickly and avert a crisis without first making sure the plan passed Congressional vetting looks like cynical politics designed to blame Republicans for Puerto Rico's problems.

Puerto Rico's 3.5 million residents deserve a better future. They deserve a serious plan.

Commentary by Douglas Holtz-Eakin, the president of the American Action Forum, and former Director of the Congressional Budget Office. Follow him on Twitter @djheakin.