STEPS TOWARD FISCAL SUSTAINABILITY
An Update on the Competitiveness of Puerto Rico’s Economy
July 31, 2014

This is taken from the section titled "Steps toward Fiscal Sustainability" in the full report.

Puerto Rico has an opportunity to restore its fiscal health, but it needs to act. In the spirit of assisting the Commonwealth in this endeavor, we describe the steps required to improve fiscal outcomes and restore access to low-cost credit:

  • Step 1: Reinvigorate efforts to raise economic growth

    It is critically important for policymakers to expand efforts to marshal the Island’s considerable strengths—a bilingual and well-educated adult population, an open economy occupying a central position in the Caribbean, wide experience as host to multinational corporations, and close ties to the U.S. mainland economy—in order to restore growth and raise living standards. Fundamentally, the government needs to reinvigorate its efforts to make the economic environment more supportive of growth, development, and innovation.

    While the challenges to restoring growth are clearly complex, we want to highlight three key areas where policies to support efficiency and growth should be strengthened. First, barriers to job creation and labor force participation need to be reduced. Second, policymakers should continue working to create a more dynamic business environment. Third, the Island should take a more proactive approach to utilizing its educated workforce and already established higher education system in the interest of economic development.

  • Step 2: Reform the Commonwealth’s tax system

    When tax rates are high, it increases incentives for activities to be shielded from taxes, perhaps by moving activity to the informal sector or by halting the activity altogether. Either way, collecting the necessary revenue requires rates to be even higher on activities that remain in the tax base, reinforcing the problem. Typically, comprehensive reform is necessary to break the cycle by simultaneously broadening the tax base and reducing rates across a range of taxes. Such a reform would likely produce a significant bonus in terms of faster economic growth, particularly in the formal sector.

    A formal effort is currently under way to evaluate the effects of Puerto Rico’s current tax system on economic efficiency, equity, and growth. That effort, the Governor’s Advisory Group for a Tax Reform, is planning to release its report at the end of 2014.

  • Step 3: Improve the Commonwealth’s financial reporting

    Puerto Rico’s unique status means that it is one of the few places in the world where finances are not regularly surveyed by a public agency. It may need to devise its own reports that are accessible to nonaccountants and allow comparability. Improved financial reporting should enhance the Island’s access to financial markets and will facilitate implementation of the following steps toward fiscal sustainability. One method for achieving this end would be to strengthen the mandate and capacity of the Office of Management and Budget, the Puerto Rico Planning Board, and/or the Puerto Rico Institute of Statistics. 

  • Step 4: Strengthen performance and harden budget constraints for public-sector corporations

    Key elements of a successful reform strategy should include strengthening the public-sector corporations’ financial standing and greatly increasing the efficiency of their operations. Additionally, future financial discipline could be enhanced through reform of public-sector corporations’ governance and ownership structures, including implementing selective privatization, setting targets for profitability and payments of dividends to the central government, strictly limiting and/or putting on a fully market basis Government Development Bank lending to the public-sector corporations, and transparently budgeting for any remaining subsidies from the central government to these corporations within a reformed budget process. Puerto Rico should also seek out the opportunity to benefit from outside expertise, especially the experiences of mainland states. 

  • Step 5: Adopt a capital budget and binding balanced-budget rule for the central government

    Given Puerto Rico’s many similarities to mainland states, it is apparent that it would benefit from adopting fiscal institutions like those of the states. By following the states’ model—splitting the budget into an operating piece that must be balanced and a capital piece that can be financed with debt—Puerto Rico could better align financing methods with its spending priorities. In addition, Puerto Rico should implement a strengthened rule for building and maintaining a “rainy day” fiscal reserve fund to improve the budget’s resilience to future economic shocks.

  • Step 6: Adopt a legislative framework requiring multiyear budgeting, specific fiscal targets, and monitoring mechanisms to help ensure those targets are met

    The Commonwealth should supplement the actions recommended in step 5 with legislative action that establishes a budget framework designed to stabilize and thereafter reduce public-sector debt to levels that would allow for flexibility in responding to future economic shocks and for financing of the Island’s investment expenditure needs. A key aspect of such a framework should be a requirement that the authorities implement multiyear budgeting, in which revenue and expenditure plans are articulated over a three- to five-year horizon. Such a framework should also incorporate a review of the central government’s macroeconomic and fiscal forecasts by a nonpartisan independent entity, whose views and analysis should be published in coordination with the Commonwealth’s proposed budget for any given fiscal year. In addition, the authorities should adopt specific targets for public-sector debt and deficits designed as a first priority to stabilize overall debt and then to gradually lower it to levels more commensurate with that of other states and/or sovereigns. 

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