Desperate Times: A Letter from Puerto Rico

by Víctor A. Ramírez García

…This is how lands were distributed to the people that remained and, since they were few, … each person received such large tracts that even today they lay fallow, … abandoned to the beasts. This vice, so entrenched in Puerto Rico, is the main obstacle that has retarded progress since the beginning. … It would be advisable to redistribute these lands to the many who lack any of their own.                  — Íñigo Abbad y Lasierra, 1782

Last year, Puerto Rico caught the attention of the international press when it declared bankruptcy. Its debt stood at $72 billion, roughly two thirds of GDP. In order to be allowed bankruptcy, Puerto Rico had to give up its fiscal autonomy in what was the culmination of increasingly desperate measures that had been taken since the recession began back in 2006:

  • Before 2006, general consumption was taxed wholesale at 6.6% (1). These wholesale taxes were replaced by a 7% sales tax on retail, surreptitiously taxing value added along the distribution chain.
  • A 4% export tax on US based manufacturing subsidiaries began in 2011. (Fortunately, this tax was offset by a Federal rebate that has been quietly renewed several times.)
  • A temporary property tax for properties over $200,000 from 2011 to 2013.
  • The University of Puerto Rico tuition was raised by 100% in 2010. Students responded with a semester long strike that was ultimately unsuccessful in preventing the increase. A second budget cut and tuition hike proposal provoked another semester long strike in 2017. Tuition will be raised another 100% in August 2018.
  • Between 2011 and 2013, two strategic pieces of revenue- producing infrastructure, namely Highway 22 in the north coast and the International Airport, were leased off for lump sum premiums as 40-year Public Private Partnerships.
  • In 2014, a 16% VAT proposal failed to gather support in the Legislature (thankfully), but nevertheless the retail sales tax was increased to 11.5%, making it the highest sales tax of any US jurisdiction.
  • Tren Urbano rail fare was doubled from $0.75 to $1.50 per ride in 2014. Metropolitan Bus service on Sundays was suspended for all but 3 routes.
  • The gasoline tax was increased in 2017.
  • 167 public schools were closed in 2017. 300 more are due to be closed in 2018.

As black flags were raised in mourning for the loss of autonomy, Maria, a once-in-a-lifetime category 4 hurricane struck. Decades of disrepair in the island’s electrical grid exacerbated the humanitarian crisis and thousands of people died from the ensuing prolonged blackout.

The Black Flag Doorway in Old San Juan. Previously sporting the official blue and red colors, the flag was painted black to mourn the loss of autonomy resulting from the 2016 PROMESA Act.

Unsurprisingly, news outlets have focused on Puerto Rico’s status when explaining the island’s afflictions. A quick Google search reveals that Puerto Rico’s debt problems can be traced back to the decade long phase out of tax breaks to US manufacturers who invested in Puerto Rico, which concluded in 2006. Nevertheless, there are signs that deeper issues are involved.

Throughout the first four decades of US domination, Puerto Rico’s economy was little more than a sugar plantation. Federal tariff barriers kept sugar prices artificially high (2). With high prices and a relatively high population density, investment in sugar mills paid off. Puerto Rico’s sugar industry achieved notable success when, at its peak, sugar exports reached a fifth of Cuba’s sugar output, with only one eleventh of the latter’s geographical size. Throughout this period, the sugar industry consolidated into a handful of players, and most fertile coastal plains were bought up by sugar barons.

Nevertheless, sugar plantations, like any large monocrop farming industry, don’t use land intensively. Most workers were employed only four months of the year with low wages. The population was dispersed throughout the countryside, with little opportunity in education or commerce. Meanwhile, more intense uses of land were constrained by sugar plantations and lack of infrastructure. Aerial photography from 1936 shows that most towns were mere specks in wide expanses of farmland.

Bayamón in 1941 surrounded by sugarcane farms, and its sprawl today

In the 1950s, the charismatic governor Luis Muñoz Marín led a movement to rapid industrialization. Using Puerto Rico’s unique status to provide a tax haven for US manufacturing firms, and ramping up infrastructure spending with funds from the Federal Interstate Highway Act, the island achieved double-digit growth. A construction boom ensued as manufacturing wages and new roads created the possibility of affordable suburban housing. Former sugar barons closed their mills and instead profited from the suburban expansion.

The postwar boom unfortunately crashed with the oil crisis of 1973, and Puerto Rico’s economy never truly recovered. Energy prices surged, and high cement prices slowed down construction (3). Meanwhile the pinnacle of the Commonwealth’s manufacturing strategy, the large Caribbean Oil Refining Company (CORCO) facility in Guayanilla, was made obsolete by high oil prices and the stroke of a Federal pen during tariff renegotiations (4). As consolation, the Federal government adopted tax rules which encouraged pharmaceutical firms — but, soon after NAFTA allowed US manufacturing to exploit cheaper labor in Mexico, the tax breaks were phased out by 2006.

Despite the fact that Puerto Rico’s manufacturing story certainly lifted many people out of rural poverty, and arguably lifted the island itself above its Antillean neighbors in terms of wages and infrastructure, a sustainable economy never materialized. The economy remained propped up by tariff barriers and targeted tax breaks, unable to hold its own. The great wave of manufacturing left economic stagnation in its wake.

Unchecked Poverty and Unemployment

The official poverty rate is 43%. In Puerto Rico, Census data from 2014 point to median house prices that are six times the median household income for that year, compared to 3 just times median income in the US. If living expenses were factored into Puerto Rico’s poverty statistics, it would be the poorest of any US jurisdiction. Housing vacancy rates stand at 21%, second only to Maine.

Another useful poverty indicator is the Gini coefficient of income inequality. Puerto Rico’s Gini of 0.54 is significantly higher than anywhere else in the US, where the average is 0.46. Historically, Puerto Rico’s Gini reached its lowest number of 0.50 in 1990 but has since continued to rise. Meanwhile, the unemployment rate has never fallen below 10% and labor participation rates have never reached 50%. The private sector is chronically weak, employing far less than half of the workforce.

Sprawl and Congestion

At the turn of the 20th century Puerto Rican towns and cities were tiny by any standards. San Juan was built on a narrow islet, with little room to grow except linearly along the road to the town of Río Piedras. A streetcar was built along the road in 1880, but a grid was never laid out beyond the city walls; private interests and geography dictated the layout of city streets in the suburbs. Recognizing the need for a more cohesive urban planning strategy, Governor Rexford Tugwell created the unique Puerto Rico Planning Board in the 1940s which, contrary to typical municipal planning practice at the time, was instead responsible for creating top down plans at the regional level. The agency was also responsible for issuing building permits for the entire island. Faced with such a daunting task, it failed to produce land use plans and neglected municipal planning needs. It ended up limiting itself to designing highways and producing high level building codes, and was buried in permit paperwork.

As the 1950s construction boom snowballed, rail was entirely abandoned and two patterns of car dependent sprawl emerged. The first pattern is informal settlements precariously built on hills, swamps, or undefended government-owned lands. The second pattern is similar to US style sprawl, composed of planned subdivisions where residential street layouts were designed in labyrinthian fashion to minimize through traffic. Traffic was dumped onto centrally maintained highways, and residential street maintenance onto municipal budgets. The fragmented and convoluted layout in Puerto Rican subdivisions make shorter distances seem longer.

In the 1980s, gated communities came into fashion with one important local innovation: enclosed streets would remain municipal since private street maintenance costs would have been too high, and that would have depressed property values. The government went one step further in 1987 when, citing elevated crime rates, it passed legislation that allowed existing subdivisions to become gated communities, while retaining municipal responsibility for streets and trash collection.

Nowadays, according to census data, the Greater San Juan Metropolitan Area spans half of the island and is home to over two million people. Long hours are wasted sitting in traffic; private cars offer the only link between increasingly distant homes and central jobs. Car ownership rates mirror those in Florida, despite workers’ limited incomes and the relatively high population density. Suburban sprawl has left doughnut holes of blight and poverty in traditional towns and cities. The former fourth-largest city in Puerto Rico, Arecibo, home of the famous radio telescope, is all but a ghost town. With adverse possession terms at an onerous 30 years and an ineffective property tax regime, blighted urban centers like Arecibo have little possibility of recovery.

Excessive Centralization

The island carries an legacy of overly centralized administration, which may or may not be linked to its colonial history. The territory is divided into 78 municipalities with no intermediate organizational level. Municipal police did not exist until 1977. Permits and urban planning functions were conditionally delegated to local governments in 1991. Even to this day, local governments still have little to no direct responsibility for education, health and social services or public transportation. The Metropolitan public transport agency (ATI) has no municipal input in either decision making or funding. Nor do municipalities control property tax collection, or last mile power distribution

Several economists and pundits have suggested that the 78 municipalities be consolidated in top-down fashion to just a handful. However, one study calculated the savings from consolidation to be about $1M for each consolidated municipality, a small gain for giving up 200 years of identity and history.

Furthermore, some municipalities have exhibited encouraging dynamism. Cabo Rojo’s government began taxing trash collection by volume using special trash bags, which seems to have been successful in reinvigorating the town’s recycling program. After Hurricane María and months of waiting for the Puerto Rico Electric Power Authority (PREPA), the town of San Sebastián snubbed the power company by organizing an illegal power brigade to fix its own residential grid.

Frozen Property Tax, Weak Enforcement

The last property tax reform occurred in 1991, when the current property tax assessment and collection agency (CRIM) was created, thus delegating functions that were previously the responsibility of the central Department of Revenue. Municipalities would participate in the decision making process, but assessments would be frozen in time. The biggest obstacle to reassessment is an exemption for owner-occupied homes, which by law is hard coded to $15,000 in assessed value. Since assessments are based on 1957 replacement costs, about 80% of homes are exempt from property tax. Updating the base year to the present day would abruptly nullify the exemption for most homeowners, as assessed values would jump at least tenfold.

The central government imposes a meager 1.03% property tax on those 1957 values, and the average effective property tax rate is 0.38% (6), which is lower than every US state except Hawaii. With limited revenues available to municipalities, around $350 million of the central government’s general fund was being handed out as subsidies to Municipalities every year.

Despite honorable mentions of property tax reform in both the Anne Krueger report of 2015 (6) and the government’s own fiscal plans of 2017 (7) and 2018 (8), such reform has yet to materialize in the Legislature. Lawmakers apparently fear a backlash, as the topic consistently fails to surface in public discourse. Nevertheless, the central government has proceeded with plans to gradually slash $175M in municipal subsidies, forcing municipalities to sharply cut their budgets, beginning with fiscal year 2017-2018.

Then there’s the issue of collection, or lack thereof. Unwilling to foreclose on outstanding debts, CRIM attempted a first sale of liens in 1997, which ultimately failed after the deal turned into lawsuits over contractual obligations. CRIM is rumored to have proceeded with less than 20 foreclosures in its entire history. Nevertheless, CRIM is currently negotiating another sale of liens for a lump sum payment of around $300M — the actual number remains unavailable to the public.

Outlook

Ever since the 1950s, Puerto Rico’s basic economic strategy has been to lure US based manufacturing companies to establish subsidiaries in Puerto Rico using federal and local tax breaks. That ship has sailed, especially when the most recent IRS Code has made the island subject to the special taxes on income from foreign jurisdictions (GILTI tax).

Unfortunately, Puerto Rico decision makers appear to be in denial. The latest iteration of the economic strategy, enacted in 2013, extended local tax breaks that traditionally applied to manufacturing to include hedge fund management and software firms. The result has been the strengthening of US expat luxury enclaves in Dorado, Condado and Palmas del Mar, where residential property values have remained high, but few new jobs for Puerto Ricans, who continue to leave the island in droves.

Puerto Rico is experiencing a death spiral with few historical precedents. The average rate of depopulation since 2006 has been 50,000 per year and has undoubtedly intensified post hurricane. Already, 15% of the 2006 population of 3.9 million inhabitants has left. Because the demographic profile of the migration is younger than those that remain, the population is aging rapidly. Even if all current debt were canceled, Puerto Rico would soon find itself in an intractable fiscal situation simply because of demographics. Land values will continue to drop, except perhaps for the wealthy US expat enclaves, so continuing to attempt to insulate landlords from the crisis is tragically nearsighted.

Desperate times call for desperate measures: the time is ripe to take decisive action toward a sustainable economy. This would entail

  • Unfreezing the real estate property tax and targeting land, aiming to scale back destructive taxes that have been imposed since 2006, as well as longstanding but equally toxic taxation practices like the movable property tax, general sales taxes and bottom-heavy income taxes. Tax reform would encourage better land use, while removing dead weight from the economy, while.
  • Further delegating central government functions to municipalities, or allowing local participation in the functions listed above. Decentralization of commercial and retail corridors would also allow municipalities to reclaim public space for pedestrians and public transportation, while using curb parking fees as a local funding source. This measure is analogous to applying land value taxation to public rights of way, and shown to be one of the most effective tools to combat car-dependent sprawl and congestion.

Addressing efficiency, equity, and land use should have been the first resort instead of the last, and so far Puerto Rico has lost 12 years to crisis and austerity. There’s a Spanish saying that translates to “No ailment lasts 100 years; no body could possibly endure it.”

Works Cited

  1. Cao-García, Ramón J., Impuestos En Puerto Rico: Treinta Años De Experiencias y Estudios. Grupo Editorial Akron, 2004.
  2. Nazario Velasco, Rubén. El Paisaje y El Poder: La Tierra En El Tiempo De Luis Muñoz Marín. Ediciones Callejón, 2014.
  3. Baralt, Guillermo A. Una De Cal y Otra De Arena: Panorama Histórico De La Construcción En Puerto Rico, 1493-2004. Asociación De Contratistas Generales De América, Capítulo De Puerto Rico, 2008.
  4. Pantojas-García, Emilio. Crónicas Del Colapso: Economía, Política y Sociedad De Puerto Rico En El Siglo Veintiuno. Ediciones Callejón, 2015.
  5. Krueger, Anne O., et al. Puerto Rico – A Way Forward.
  6. Puerto Rico Fiscal Agency and Financial Advisory Authority. Fiscal Plan for Puerto Rico – Draft.
  7. Puerto Rico Fiscal Agency and Financial Advisory Authority. Fiscal Plan for Puerto Rico.
  8. Puerto Rico Fiscal Agency and Financial Advisory Authority. A New Fiscal Plan for Puerto Rico.
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