To Address Puerto Rico’s Debt Problems, Look Beyond Chapter 9, Support Comprehensive Reforms

by Pete Sepp / /


Dear Member of Congress:

On behalf of National Taxpayers Union’s (NTU’s) members across the nation, including those residing in Puerto Rico, I urge you to think beyond what may appear to be “easy fixes” for the Commonwealth’s fiscal crisis and instead enact measures that will encourage long-term reforms to tax, budgetary, and regulatory policies. Last week’s announcement from Governor Garcia Padilla that the island’s $72 billion debt is “not payable” may underscore the urgency of Puerto Rico’s fiscal crisis. For Congress, however, this declaration should serve as a reminder to act thoughtfully rather than precipitously.

Before rushing to pass legislation making Puerto Rico’s public corporations and municipalities eligible for Chapter 9 bankruptcy, NTU believes that lawmakers should carefully consider the words of Representative Jeff Duncan, Chairman of the Subcommittee on the Western Hemisphere of the Committee on Foreign Affairs.

According to news accounts from June 19, Chairman Duncan wrote in a Dear Colleague letter that, “… legislation to require the establishment of a financial control board, to enable the politically unpalatable changes necessary to put Puerto Rico back on the road to self-determination, may be needed.”

For several months prior to Chairman Duncan’s letter, Puerto Rico’s Governor, Resident Commissioner, and some Members of Congress have emphatically recommended passage of Chapter 9 legislation (HR 870) in the House. Hearings were held on the bill in a subcommittee of the House Judiciary Committee. Moreover, Senator Schumer has stated that he is working with colleagues to build support for such a proposal in his chamber. The Administration has likewise called for a simple, straightforward grant of Chapter 9 protection for Puerto Rico.

Instead of immediately committing to this course, Congress must weigh all options. The following comments from NTU are lengthy, but the matter at hand is complex.


The Chapter 9 Experience Is Mixed. It is true that Chapter 9 can furnish municipalities in U.S. states the opportunity to overhaul unaffordable, unrealistic spending and benefit programs. In the process, taxpayers at the state or federal levels could be spared the ignominy of being forced to fund bailouts.

Unfortunately, this approach has not been a cure-all. In a May 12 Examiner article, former Under Secretary of State (and American Enterprise Institute Fellow) James K. Glassman wrote:

Some conservatives are drawn to Chapter 9 as a way to force cuts in union members’ pension benefits. But the courts frequently reject those cuts. Stockton, Calif., for instance, emerged from bankruptcy in 2014 with a sales tax increase, haircuts for creditors, but no pension reductions. Chapter 9 is an utterly unpredictable process that can drag out for years. Vallejo, Calif. spent 42 months in bankruptcy court, and San Bernardino entered bankruptcy in 2012 and still hasn’t exited.

Manhattan Institute Senior Fellow Stephen Eide concurred with this assessment as he analyzed California’s government employee pension liabilities for the June 29 edition of The Weekly Standard. He quoted Vallejo Vice Mayor Stephanie Gomes, who lamented that “When we had a chance, in the court, with the judge, to renegotiate, [the majority on the city council] chose instead to give raises and free health care.”

Municipal bankruptcies have been quite rare in recent times, but this is all the more reason to study thoroughly the implications of proposals to expand Chapter 9. For instance, will revisiting Chapter 9 in this context embolden U.S. states to call for more debt-restructuring latitude? After all, several state governments have incurred serious liabilities in their own right, over and above those facing localities.


Chapter 9 Alone May Not Produce the Desired Stability Puerto Rico Needs. Past experience with municipalities aside, some policymakers feel that in Puerto Rico’s case Chapter 9 is a way of avoiding, rather than precipitating, a federal taxpayer bailout or higher taxes on the island. Here again, this is a risky proposition.

For one, Chapter 9 would be especially difficult to implement amid Puerto Rico’s opaque public institutions. Only recently has PREPA, the state-owned electricity company, begun to reverse what the entity’s own Chief Restructuring Officer called a tendency to make “management and other strategic decisions … based on political considerations rather than best practices or sound business judgment.”

A reason why this may be occurring is, ironically, the same reason why Chapter 9 may be unnecessary.

Investors, who are insisting upon transparency during negotiations to resolve $9 billion of PREPA debt, are beginning to see it … and with it, a light of resolution at the end of what has been a bleak tunnel. However this question is resolved, clearly other portions of Puerto Rico’s government will require major improvements in transparency before there would even be sufficient information to proceed with a Chapter 9 reorganization.

Some say that regardless, Chapter 9 bankruptcy would still work to keep the specter of a taxpayer bailout at bay. Yet, as one expert told House Judiciary Committee members, Chapter 9 is the “Wild West” in bankruptcy law. The process to settle debt obligations could take years and could be very expensive. If these procedures became too arduous to complete, the political temptation to bail out indebted entities with taxpayer money could actually grow.

Finally, there have been only sporadic indications so far of the political will that Puerto Rico’s institutions would need to fairly carry out Chapter 9 for the benefit of their citizens, i.e. by setting budgetary priorities and increasing the island’s economic development.

Indeed, much of the evidence points in the opposite direction: without other forms of guidance beyond Chapter 9, unhelpful steps could be a first resort. A recent, huge increase in Puerto Rico’s sales tax rate, along with a tax on services, may have provided temporary cash flow to the government and rallied bond markets, but policies such as these are counterproductive in the long run by pushing the island’s own innovators away from its shores.

Congress must pay close attention to crafting a legislative response that does not implicitly condone Puerto Rico’s past fiscal policy mistakes and thereby trigger new ones. Otherwise, Congress could be seen as paving the path for Puerto Rico to walk away from its debts. Broad, energetic reforms beyond Chapter 9 – as well as a commitment to the rule of law – are vital.


To Avoid a Bailout over the Long Term, Create Safeguards for Taxpayers. As a U.S. territory, Puerto Rico’s misfortune affects the entire nation, not only in terms of trade or business activity, but also in terms of fiscal policy. Even as most “mainland” Americans anxiously await signs that the economic recovery has moved beyond its anemia, Puerto Rico’s prognosis has been steadily worsening. With at least $73 billion in debts, the Commonwealth is for all intents and purposes insolvent. Ominous budget deficit projections, unfunded pension obligations, and maladministration of the tax system only contribute further to doubts about Puerto Rico’s future economic health.

Taxpayers face the unwelcome prospect of a bailout of Puerto Rico’s debts unless a far-reaching solution is found. Thus, the path to arriving at appropriate legislation that reflects all concerns over resolving Puerto Rico’s debts will require cooperation among Members of many ideologies, between both chambers, and across several committee jurisdictions.

For these reasons, Congress should do more than pass a mere “debt restructuring” bill. For example, creditors have voluntarily agreed to provide billions in new financing to Puerto Rico’s power utility. Legislation should encourage rather than cut off this option to Chapter 9.

Furthermore, House Judiciary Committee Chairman Goodlatte rightly raised concerns that HR 870’s provisions to “retroactively impact investors’ rights should be reviewed with care and caution.” On this matter, Chairman Goodlatte is in a great deal of company. Over nine million Americans have a portion of their retirement savings invested in Puerto Rico’s bonds. A poorly implemented Chapter 9 procedure could undermine the rights of these investors, who took their decision-making cues from Congress itself, when the law made these bonds tax-exempt in every state.  As renowned economist Richard Rahn, Chairman of the Institute for Global Economic Growth, noted in the June 22 Washington Times:

Those who bought Puerto Rican bonds did so with the legal understanding that they would not be            subject to Chapter 9 and that, in the case of insolvency, the bond issuing entity … would be put under a        receivership instead. … Chapter 9 might make sense for future bond issues, but the bond buyers should    clearly understand the course that would be taken in case the issuing agency was not able to pay.

Ultimately, structured oversight would provide precisely the right kind of environment in which such a receivership could generate the maximum good for all stakeholders.

The District of Columbia’s financial control board, which helped to restore stability to that government’s finances, might be adaptable to Puerto Rico’s circumstances. The experience of Harrisburg, Pennsylvania, is also instructive. While not subject to a federal control board, the state-appointed receiver functioned in a similar manner by assisting with the divestiture of mismanaged facilities that Harrisburg never should have owned. Although taxpayers were certainly not unscathed by the plan, the result demonstrated that receivership is a workable alternative.


Conclusion: Think Comprehensively, Act Inclusively. A bipartisan approach toward a control board, untethered from Puerto Rico’s internal politics, would make it easier to pare back unnecessary government functions, implement true tax reform, and put the public corporations on a path to financial sustainability. Throughout this institutional overhaul, investor rights and contracts should be protected. Such an entity should be overseen or administered under the guidance of the legislative branch.

Congress could also consider reforming Jones Act cargo preferences, which severely hamper Puerto Rican commerce. Commonwealth officials should be encouraged to strengthen beneficial policies (e.g., capital gains tax treatment and constitutional balanced budget requirements) while overhauling detrimental ones (e.g., arbitrary tax administration, uncompetitive wage laws, and burdensome regulations).

A control board need not be created as some kind of punishment mechanism for the Commonwealth; rather, it can serve as a collaborative exercise to the advantage of all. Although District of Columbia officials were understandably wary – or even dismissive – of the project, many came to recognize the importance of the control board concept in helping to transform the city’s fiscal outlook.

The late Mayor Marion Barry commented in a 2011 interview with The Washington Post that the federal control board “was able to do some things that needed to be done that, politically, I would not do … .” Delegate Norton observed that although the control board still casts a shadow “over every elected official today,” its legacy was to have “promoted … a kind of fiscal responsibility that was not always the case for the District.”

This effort at turning around the District of Columbia was not easily won; nor was it marked by some grand era of political reconciliation among elected officials. Rather, it was recognition among leaders with good intentions that reaching consensus over urgent reforms they could not otherwise achieve required structural boundaries and systematic discipline. Some 20 years later, Puerto Rico needs such an effort.

Earlier this year, National Taxpayers Union noted in comments to the Judiciary Committee’s Subcommittee on Regulatory Reform, Commercial and Antitrust Law that “if Congress takes the significant step of extending Chapter 9 to Puerto Rico’s public corporations and municipal entities but ignores the need for broader restructuring, it will miss an opportunity to bolster the rule of law and effective governance in Puerto Rico and beyond.”

More recently your colleague Chairman Duncan eloquently stated that a Chapter 9-dominated solution to the current situation could be tantamount to “a financial bailout of Puerto Rican debt that will provide only temporary benefit, harm U.S. investors that have invested in Puerto Rican bonds, and not meaningfully address the entrenched issues that have created the fiscal management problems that have created the current crisis.”

Thank you for your consideration of these lengthy remarks as you devise a legislative response to Puerto Rico’s dire financial condition. Time is short, but still abundantly sufficient to do what is right for taxpayers.


Pete Sepp