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What the States Can Learn From the Island of Enchantment 

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Day after day, we continue to read stories on the budget battles and heated union protests in some states around the country. I don't know about you, but I'm getting tired of all this negativity.

I decided to seek out a local government who is doing it right for a change and my pursuit sent me to the sunny, sandy shores of the U.S. unicorporated territory of Puerto Rico.

It may be considered a vacation spot for many but 3.966 million people live on the island, making it one of the most densely populated islands in the world. Puerto Rico's economy wasn't too sunny two years ago when the new Governor Luis Fortuño (a Republican) took what some considered drastic steps in cutting the $3.2 billion 2009 budget deficit. It was the worse than any of the fifty States.

Staring at near junk bond levels, Fortuno knew he had to do something. He started by cutting 30,000 public jobs as well as eliminating selected business tax credits and raising some company and personal taxes. At the time, 70 percent of the island's budget was government employee salaries and benefits.

Today, the hard decisions have made a significant dent into the island's budget deficit, dropping from nearly 44 percent to less than 11 percent. Moody's has since raised Puerto Rico's bond rating from Baa3 to A3, the highest rating in 35 years. I asked Secretary of Economic Development and Commerce, Jose Ramon Perez-Riera to share their strategies.

LL: The budget battles in Wisconsin, Ohio and Indiana are just some examples of what some states are facing. Do you think the Governors are using this as a chance to push their austerity measures or do you think they are doing the right thing?

RPR: One of the most important things any governor can do is keep his or her state on sound financial footing. When your budget is out of balance, you can close the gap by cutting spending, raising taxes or some combination of the two. In Puerto Rico, we chose to lead by cutting spending, which is what the governors in the three states you referenced are trying to do.

Government cannot be seen as the employer of last resort. It stifles private sector growth and the creation of a wide array of jobs.

We believe that our two-year old program, which could be seen as a model for other governors, will continue to lead the way to long-term, sustainable growth.

LL: Puerto Rico has managed to turn around its economic situation. What steps did you use that were most effective?

RPR: Our program started with two initiatives. The first was to get our budget situation under control and the second was to implement a comprehensive plan to revive the economy.

Shortly after Governor Fortuño was elected, we discovered that the budget deficit was $3.3 billion (44 percent of revenues) and the island’s debt was teetering at junk status.

Almost 70 percent of the budget was government employee salaries and benefits. There was not enough money in the treasury to make payroll.

In two years, we cut the overall budget by 20 percent and reduced the budget deficit as a percentage of revenues to less than 11 percent. We shrank government employment rolls by 17,000, closed out defined benefit pension plans, and eliminated government agencies.

As a result, Puerto Rico’s bond rating with Moody’s has leaped from Baa3 to A3, the highest it has been in 35 years, and we have received upgrades from Standard and Poor’s and Fitch. These upgrades have convinced many in the business community that we are serious about getting our economic house in order.

Our second initiative was our Strategic Model for a New Economy. This plan outlines everything we want to do to reform our economy and make it more competitive compared to other states and other countries. We set the Island on the path to be the most pro-growth jurisdiction in the Western hemisphere.

This included changing the way the government interacts with business and offering incentives for companies to do business on the Island. We want to demonstrate to the world that Puerto Rico is open for business and so far, companies are listening. We still have more to do to complete the economic turn around, but we are not done reforming our economy to make it more business friendly.

LL: What can states facing fiscal challenges learn from Puerto Rico?

RPR: I think there are two lessons. First and foremost, get your fiscal house in order.

Governor Fortuño was elected to turn around an economy that slipped into recession two years before the rest of the country. Rather than enact stop-gap measures, he made the tough decisions that are turning around the economy and improving our competitive position. Cutting employees and popular programs is never easy, but without taking decisive steps, Puerto Rico would have been insolvent.

The second lesson is to use this as an opportunity to make fundamental changes that will make your government more competitive. For us, it was imperative that we reduce the government payroll. We had to learn to do more with less. As part of the overall program, we also took the opportunity to cut red tape that was deterring economic development. These were long-overdue changes.

We also used the opportunity to cut taxes by $1.2 billion and make some strategic investments. Our tax rates were simply too high. Governor Fortuño slashed individual tax rates an average of 25 percent this year and the tax cut will reach nearly 50 percent over the next several years. Corporate rates have been cut by 30 percent and the former, seven-tier tax structure, has been simplified to three lowered rates.

We also enacted programs to support key industries.

For example, our housing program has resulted in a 20 percent increase in home sales over the first four months of the program. Our support for public-private partnerships is also producing results, bringing new investment in key areas such as transportation infrastructure, energy generation and urban redevelopment. Turning around an economy and making it more productive not only takes time, but it’s something you can’t do alone.

So, we’ve dedicated a great deal of time and energy to seeking out the best organizations to partner with, looking for those which can contribute to Puerto Rico, not merely profit from doing business on the island.

LL: President Obama has been traveling to battle ground states that will be crucial to his re-election bid- Wisconsin, Michigan, Pennsylvania and this week he is going to Florida. Do you think his economic message is resonating with Americans?

RPR: One of the things that we found out from the mid-term election is that the American public is primarily concerned about creating jobs and lowering unemployment.

The challenge for the President is to turn around an electorate in key battleground states that abandoned him last year. I think that it will be easier for him to make the case that his program was the right one once the economy improves.

LL: What is the biggest threat to the U.S. economy?

RPR: I think the biggest threat in the short term is from higher gasoline prices because of the instability in the Middle East. As gas prices rise, families are forced to spend more on fuel and cut back on other purchases. It will negatively impact small- and medium-sized businesses that depend on transportation to get their goods to market.

As an island that gets 70 percent of its electricity from oil, relies on tourism and has to import many goods and materials sold on the island, Puerto Rico will be impacted sooner and more harshly than most states.

This situation confirms our administration’s commitment to kick our oil habit and diversify our sources of energy. Even before the current unrest in the Middle East we had a program in place to retrofit our oil-powered electricity plants, so that we will get 70 percent of our electricity from natural gas by 2014. We are also pushing renewable fuels, including wind, solar and kinetic sources. We are committed to making these kinds of strategic investments that will help us create a pro-growth economy and enhance the life of every Puerto Rican.

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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."