In September, Puerto Rico was devastated by Hurricane Maria, a category 5 storm. The devastation to the island of such an horrific storm was the final blow to an area already financially bankrupt.
Puerto Rico filed bankruptcy on May 3, 2017 after decades of financial decline, dependency, governmental mismanagement and ineptitude of the bureaucracy.
There were systemic problems that existed in Puerto Rico that will perhaps serve as an example of what happens when governments interfere with free markets and are not held accountable to the people they are charged to serve. As we all work together to solve the crisis relating to the hurricane, perhaps it would be useful to understand how the island was devastated prior to the hurricane by harmful “feel good” programs which made it unable to withstand this devastating storm. The understanding of the root causes of the financial collapse prior to the storm will facilitate a long term meaningful rebuilding of such an island paradise and perhaps provide insight to help avoid such disastrous government interventions in other areas.
The mismanagement of infrastructure and government entities in Puerto Rico have been documented for decades. During the Obama administration, the Department of Justice sent a cautionary letter to the governor of Puerto Rico concerning financial irregularities and internal control weaknesses. Puerto Rico was placed on a watch list with oversight controls on DOJ grants.
Such weaknesses and irregularities existed in the government for an extended period of time. The government of Puerto Rico had been frequently characterized as inept and riddled with corruption.
Behind this financial chicanery there are people, people who have been hurt almost irreparably by government programs and by a government that was allegedly there to help them. In large measure our federal government bears a great deal of this burden as does the government of Puerto Rico, it’s municipalities, and candidly its people.
While we are rebuilding the island we must also rebuild the framework under which Puerto Rico operated.
For decades, Puerto Rico benefited from U. S. Government largess.
The tax haven status began in 1976 when Congress enacted section 936 of the tax code which allowed US companies to repatriate earnings at preferential tax rates. This section was changed in 1996 with the complete phase out by 2006. Therein began the decline for this island nation.
After the incentives were phased out, there ceased to be economic incentives for companies to remain on the island. At that time, an extensive migration took place from Puerto Rico to the United States which is continuing to this day.
Rather than utilizing this special tax exemption to build a competitive infrastructure, the government of Puerto Rico squandered its opportunity because there were no incentives required to earn that tax-exempt status. This lack of incentives which is present in a free market system frequently causes social welfare programs to backfire and having unintended consequence of hurting more people that it helps. In this case an entire island was hurt perhaps irreparably.
To reverse the tide of the repeal of Section 926 of the tax code, Act 20, Act 22, Act 27 and Act 73 were enacted. They provide exceptional tax incentives to locate in Puerto Rico. These current laws permit mainland U. S. residents to avoid substantial federal taxes. It is a true tax haven. The new laws slowed the decline but the ineptitude of government failed to capitalize of the new opportunity.
The population of Puerto Rico peaked at just under 4 million in the early 2000’s and is now 3.47 million and declining. The labor force participation rate in Puerto Rico is under 40% or almost 20 points lower than in the United States. Much of the labor problem and population decline are negatively impacting the ability of the island to recover.
As so frequently happens, governmental programs designed to help actually created a dependency leading to the eventual demise of the very people it claimed to be helping.
The understanding of the crisis in Puerto Rico will help us understand that we must ensure that we do not foster dependency but instill self-sufficiency as we rebuild.
The case study with Puerto Rico would serve well to be a blueprint for the other states in the United States experiencing financial decline. The benefits of such a detailed analysis would also provide insight into whether other programs minority set-aside programs and affirmative action are really helping or hurting those in need.
In reality, most times when government interferes with the free market system other than by providing a framework of laws within which a free market system can operate freely, market inefficiencies almost always arise. Those market inefficiencies, if left unchecked, create a breeding ground for dependency, ineptitude, inefficiency, and finally bankruptcy.
Col. Frank Ryan, CPA, USMCR (Ret) represents the 101st District in the PA House of Representatives. He is a retired Marine Reserve Colonel and served in Iraq and briefly in Afghanistan and specializes in corporate restructuring. He has served on numerous boards of publicly traded and non-profit organizations. He can be reached at [email protected].