Washington’s Role in Puerto Rico’s Mess

The Puerto Rican government, which has spent wildly, is principally at fault for the crisis. But Washington, D.C. deserves a large portion of the blame for Puerto Rico's mess.

Flawed policies from Washington have aided Puerto Rico's descent into fiscal insolvency in a number of ways. Washington inflated the island's transportation costs, destroyed the island's labor market with an abnormally-high minimum wage and lavish entitlement programs, and pushed flawed tax policy that created an economic bubble.

Islands have higher-than-normal transportation costs due to their remote locations, but a pre-New Deal era law drives up the cost even more for Puerto Rico. The Jones Act decrees that goods being shipped between U.S. ports must be on U.S. chartered ships with a U.S. crew. That means goods coming from the mainland can't come on the most cost-competitive vessel. They must go with one of four U.S. shippers operating that route. The limited competition increases costs. Puerto Rico's shipping costs are twice those of its island neighbors, making items more expensive to purchase on the island. It also limits Puerto Rico's ability to export its products to the mainland.

The federal minimum wage of $7.25 an hour applies on the island. The minimum wage's effects are well-known, but it has disproportionate influence in Puerto Rico.

The island's median income is only 40 percent of the mainland. Twenty-eight percent of Puerto Rico residents earn $8.50 an hour or less, compared to 3 percent on the mainland. So the minimum wage greater impact in Puerto Rico. It would be like if the mainland had a $19 an hour minimum wage.

The high minimum wage raises the cost of employment and prices many employers out of the market, causing unemployment to rise and thus tax revenue to dry up.  The minimum wage is a partly why the island's unemployment rate is almost three times that of the mainland.

The minimum wage is coupled with lavish entitlement benefits. A household of three in Puerto Rico can earn $1,700 a month in benefits from Medicaid, food stamps, utility subsidies, and aid for dependent children, compared to $1,150 a month in take-home benefits from the minimum wage. Individuals are better off not working, and many chose that option. Only 40 percent of Puerto Rico residents are employed or looking for work, compared to 63 percent on the mainland.

Finally, Washington fueled the Puerto Rico bubble with inconsistent tax policy. Per Congress, Puerto Rican municipal bonds are exempt from federal taxation—like other states—but they are also exempt from state and local taxes too. Triple tax exempt bonds are a great investment. That attracted buyers to the bond market, allowing Puerto Rico to issue billions and billions in debt cheaply, and postpone spending restraint.

In 1976 Congress allowed U.S. corporations with subsidiaries in U.S. territories, including Puerto Rico, to avoid federal taxation on dividend payments to the parent company. In essence, U.S. firms could relocate large portions of their business to Puerto Rico to avoid federal taxation. As expected, many firms took advantage and the island's economy grew rapidly, but nothing lasts forever. In the mid-1990's, Congress and President Clinton phased out this provision over a ten year period. Firms closed up shop on the island and moved. Puerto Rico's 10 year depression began in 2006, the first year after tax preference ended.

Puerto Rico's inability to limit spending, reform its protectionist labor laws, and institute broad pro-growth tax reform all contribute to its precarious debt situation. But it isn't alone. Bad policies from Washington have made the pain much worse.