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Tax Hikes Cannot Save Puerto Rico From Its Debt: Study

by Mike Godfrey,, Washington

06 July 2015

A study for the Puerto Rican Government has indicated that, while the country may be able to increase tax revenue in the short term, a solution to its persistent fiscal deficits will not be possible over the next decade without debt relief from its creditors.

The study, by Anne Krueger, a former World Bank Chief Economist and former Deputy Director of the International Monetary Fund, and currently a Senior Research Professor at Johns Hopkins University, found that Puerto Rico's "true fiscal deficit is much larger than assumed. Even a major fiscal effort leaves residual financing gaps in coming years, which can [only] be bridged by debt restructuring."

It is noted that "special tax exemptions from the US tax code attracted businesses to Puerto Rico for a number of years, … but they were removed starting in 1996. Since then, there has been virtually no economic growth in Puerto Rico. Attempts to 'offset the recession' with expansionary fiscal policy financed by borrowing have been made for the past two decades."

Krueger calculated that Puerto Rico's total borrowings (that have been boosted in the past by its bonds being tax exempt) have reached US72bn, or over 100 percent of its gross national product. Even with a reduction in tax expenditures and credits, a revamping of property tax, and the recently enacted hike in sales and use tax, "a large residual financing gap remains for the next decade."

She pointed out that, overall, "such tax measures (or others similar to them) could raise receipts by USD1bn in 2016, USD3bn annually by 2020, and USD4bn annually by 2025. … [However,] a significantly larger adjustment would result in reduced growth and therefore not achieve the desired outcomes."

In his reply to the study, Puerto Rico's Governor Garcia Padilla said: "It is no secret that the Commonwealth has faced fiscal issues over the last decade. However, the report from Krueger and her team – commissioned at the request of the Commonwealth – for the first time acknowledges the true extent of the problem."

Picking up on her conclusions, he noted that a Puerto Rican credit default could be near, unless a debt restructuring can be agreed. He has confirmed that, in an upcoming meeting with its creditors, the Government will look for a moratorium on repayments and some form of debt relief.

TAGS: tax | economics | sales tax | property tax | fiscal policy | tax credits | Puerto Rico | tax breaks

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