PUERTO RICO’S SELF-INFLICTED CRISIS
For Puerto Rico’s private sector, and a number of economists, the economic recession crisis is self-inflicted. So what can Puerto Rico do about it?

This island, of course, is seriously affected by global economic forces that are beyond its power: the brutal increase in the price of oil, the banking and mortgage credit crisis. But because the severity of this island’s economic recession is self-inflicted, once the global situation changes, unlike in the past, Puerto Rico will continue sinking in recession.

There are three things, according to the private sector and economists, that this island must do. One, the political parties in power must recognize that the endless partisan warfare of the past three years, the shared government where the Governor and Legislature belonging to competing parties had led often to gridlock, has damaged the economy. The partisan gridlock has obstructed the government in attempting to respond and adjust to the global challenges.

Second, Puerto Rico needs a consistent economic development policy. The Governor and the Legislature, as a result of the partisan warfare, one day enacts a pro-growth measure and the next day annuls it with an anti-growth measure. The result is that no one on this island, or in the world, today can say if the Government of Puerto Rico is “pro-business” or “anti-business.”

Puerto Rico needs a deep tax reform, including significantly lowering Puerto Rico’s high corporate income tax – today one of the highest in the world. It needs to stop legislating politically-motivated economic benefits that, in the end, cost Puerto Rico thousands of jobs making this island less and less competitive in attracting investment.

But, third, nothing will work unless Puerto Rico greatly reduces the bureaucratic monster: the enormous dead weight of over two hundred thousand government employees that soak up the billions in tax revenue.

But there is something else.

Lets assume that come January, 2009, the political warfare that has so seriously hurt the economy comes to an end. Either the newly- elected Governor and Legislature belong to the same party. Or we have again a “shared government” but this time the parties decide to work together to confront the recession.

The newly-elected government will be faced with a gigantic deficit now calculated at nearly $1 billion that may well get bigger. The more the economy slows down the lower the tax revenue. From 2007 to 2008, corporate tax revenue declined by 21.8 percent: $437 million. Individual tax revenue went down by 9 percent: $278 million. The lower the tax revenue the greater the budget deficit and the less the government can do to spur the economy.

And caught in this vicious circle, it becomes extremely difficult to enact a deep tax reform. Puerto Rico learned decades ago, as now have most economies in the world, that paradoxically the way to increase tax revenue is precisely lowering taxes that will generate economic growth. Politically, needless to say, its easy to lower individual taxes for the middle class, but extremely difficult for high income people and corporations, precisely what will ignite economic growth.

But of all the things the newly- elected government must do, there is one that will be the most difficult. And here we get to the “something else.”

Recently the head of the Government Budget Office, Armando Velez, pointed out something critically important. Since the Governor Anibal Acevedo administration took over in 2006, it has reduced the bureaucratic monster. It has reduced the number of employees in the Executive Branch by 16,631 – from 207,536 to 190,903. This is a lot. There are 4,000 less employees in the Education Department: 3,000 public workers less in the prison system.

Yet, he said, the government payroll has continued to increase. And the reason, he said, is “collective bargaining.” Law 45 approved in 1998 by the Governor Pedro Rossello administration legalized public employees to unionize with the right to negotiate salaries and economic benefits. The Budget Office, he said, desperately cutting costs wherever possible, had to come up with $200 million more for salary increases recently negotiated, or approved under great union pressure.

This is not exactly news. Back in May, the private Center for the New Economy analyzed the 2009 budget and found precisely the same. While the number of public employees declines, and in fact, total government spending declines, the public payroll increases.

But, again, as Puerto Rico sinks deeper and deeper into recession, it is now more critical than ever to understand the implications of what the head of the Budget Office is saying. Faced with a billion dollar deficit that may get much worse, cutting employees as much as it has, the administration is in fact powerless to control salaries. And if it cannot control salaries, it effectively does not control the government budget.

There is reason to believe, I think, that after the November elections, there will be a truce in the destructive partisan warfare. But working together in itself does not guarantee good economic policy. There is no better example than Law 45. All the parties came together in support of it back in 1998, and still support it today.

And there is no better example of how Puerto Rico’s economic crisis is self-inflicted than Law 45. No one should hold their breath waiting for the political parties to amend it, much less repeal it. But this does not change the reality. To pull this island out of the deepening recession, it is simply essential that the government regain the critical power it surrendered in Law 45 – the power to control the public payroll. That is, the power to control the government budget: the power to control the bureaucratic monster.