Catalysts to Fiscal Recoveries

November 10, 2017

Good Morning! In today’s Blog, we consider the ongoing challenges to Detroit’s recovery from the nation’s largest ever chapter 9 municipal bankruptcy; the State of Michigan’s winnowing down of municipalities under state oversight; and the ongoing physical and fiscal challenges to Puerto Rico.

Visit the project blog: The Municipal Sustainability Project 

Reframing the Motor City’s Post Chapter 9 Future. Nolan Finley, a wonderful contributor to the editorial page of the Detroit News, this week noted “elections are a wonderful catalyst for refocusing priorities, as evidenced by the just-completed Detroit mayoral campaign, which moved the city’s comeback conversation away from the downtown development boom and centered it on the uneven progress of the neighborhoods. Never before has such an intense spotlight shown on the places where most Detroit voters actually live.” He attributed some of the credit to the loser in this week’s mayoral election, challenger Coleman Young II, who forced Mayor Mike Duggan to defend his record on improving quality of life in the neighborhoods. He perceptively wrote that while candidate Young’s ugly “Take back the Motherland” rallying cry was dispiriting, it spoke to the governing challenge the newly, re-elected Mayor confronts, writing: “Detroit is not a city united. It must become one. There were too many skirmishes along the racial divide in this mayoral contest. The old city versus suburb story line was replaced by a neighborhood versus downtown narrative, but both are code for black versus white. Four years ago, Duggan’s election as Detroit’s first white mayor in 40 years suggested much of the city was ready to stop looking back at its dark and divisive past and begin focusing on a brighter future.” Now, he wrote, after Mayor Duggan focused his first term on meeting the city’s plan of debt adjustment, and trying to improve the quality of life for residents—and as developers are beginning to add community projects to their downtown portfolios, “too many in the neighborhoods feel as if their lives are not getting better, or at least not fast enough.” Thus, he noted, Mayor Duggan needs to redouble his efforts to restore the city’s residential communities, and push ahead the timetable: “Four years from now, Detroit cannot still be wearing the mantle of America’s most violent city.” He added that while Mayor Duggan has little—too little—authority to address education in Detroit; nevertheless—just as his colleague Rahm Emanuel, the Mayor of Chicago recognized, needs to strongly back Detroit Public School Superintendent Nikolai Vitti’s efforts to rapidly boost the performance of the Detroit Public Schools Community District: it is a key to bringing young families back into the city. And, Mr. Finley wrote, the mayor “must also find a way to connect the neighborhoods to downtown, to instill in all residents a sense of ownership and pride in the rejuvenation of the core city. That means getting way better at inclusion. Downtown’s comeback must be more diverse, and include many more of the people who have grown up and stayed in the city. Encouraging and supporting more African-American entrepreneurs is a great place to begin breaking down the perception that downtown is just for white people: Detroit needs more diversity everywhere in the city, both racial and economic,” referring especially to young millennials who are steeped in social justice and imbued with the obsession to give back that marks their generation. “They are committed Detroiters. And they deserve to be appreciated for their contributions, not made to feel guilty or viewed as a threat to hard-won gains.”

Free, Free at Last. Michigan State officials have released Royal Oak Township, a municipality of about 2,500 just north of Detroit, from its consent agreement: Michigan Treasurer Nick Khouri said the Oakland County municipality has resolved its financial emergency and is ready to emerge from the state oversight imposed since 2014, stating: “I am pleased to see the significant progress Royal Oak Charter Township has made under the consent agreement…Township officials went beyond the agreement and enacted policies that provide the community an opportunity to flourish. I am pleased to say the township is released from its agreement and look forward to working with them as a local partner in the future.” The township’s financial emergency resulted in an assets FY2012 deficit of nearly $541,000. Township Supervisor Donna Squalls noted: “Royal Oak Charter Township is in better shape than ever…The collaboration between state and township has provided an opportunity to enact reforms to ensure our long-term fiscal sustainability.” Treasurer Khouri also said the township was the last Michigan remaining municipality following a consent agreement: Over the last two years, Wayne County, Inkster, and River Rouge were released from consent agreements because of fiscal and financial improvements and operational reforms. The Treasurer noted that today only three communities, Ecorse, Flint, and Hamtramck, remain under state oversight through a Receivership Transition Advisory Board.

Preempting Authority. House Natural Resources Committee Chair Rob Bishop (R—Utah) this week said the PROMESA Oversight Board should be granted even more power to preempt the authority of the government of Puerto Rico, stating: “Today’s testimony will inform the work of Congress to ensure the Oversight Board and federal partners have the tools to coordinate an effective and sustained recovery,” in a written statement after a hearing of the House Committee on Natural Resources: “It is clear that a stronger mechanism will be necessary to align immediate recovery with long-term revitalization and rebuilding.” Chairman Bishop added: “This committee will work to ensure [the Puerto Rico Oversight Board] has the tools to effectively execute that mission and build a path forward for this island and its residents.” The Board was created last year to oversee fiscal management by the island government, which had said more than $70 billion of debt was unpayable under current economic conditions. Since the hurricane, the Board has clashed with the territorial government over leadership at the power utility. During the hearing the board’s Executive Director, Natalie Jaresko, said the ability of Puerto Rico’s government to repay its debt was “gravely worse” than it was before Hurricane Maria, which arrived Sept. 20. By the end of December, the Board plans to complete a 30 year debt sustainability analysis with Puerto Rico’s government, she said: “After the hurricane, it is even more critical that the Board be able to operate quickly and decisively…to avoid uncertainty and lengthy delays in litigation, Congressional reaffirmation of our exercise of our authority is welcome.” On Oct. 27, the board had filed a motion in the Title III bankruptcy case for the Puerto Rico Electric Power Authority (PREPA) seeking the court’s permission to appoint Noel Zamot as the authority’s new leader. The government of Gov. Ricardo Rosselló has made it clear that it intends to challenge this motion. The court is scheduled to hold a hearing on the matter on Monday, November 13th.

In calling for more board power, Chairs Bishop and Jaresko probably were at least partly referring to the struggle over PREPA’s leadership. They may also want the Board’s power augmented in other ways: the Board has already announced that it will be creating five-year fiscal plan for Puerto Rico’s government and for its public authorities this winter. Puerto Rico’s government will have substantial needs for federal aid in the coming years, Ms. Jaresko said. Congress plans to tie this aid to the government following the Board’s fiscal plan and this would be appropriate, she said. “Before the hurricanes, the board was determined that Puerto Rico and its instrumentalities could achieve balanced budgets, work its way through its debt problems, and develop a sustainable economy without federal aid,” Ms. Jaresko said in her written testimony. “That is simply no longer possible. Without unprecedented levels of help from the United States government, the recovery we were planning for will fail.” She also said that over the next 1.75 years Puerto Rico’s government will need federal help closing a gap of between $13 billion and $21 billion for basic services. She added the federal government should change tax laws to benefit the island: “The representatives of the Financial Oversight and Management Board (FOMB) who appeared before the House Committee on Natural Resources insist on jeopardizing the necessary resources for the payment of pensions and job stability,” Gov. Rosselló testified in his written statement, adding to that the testimony of Ms. Jaresko and Mr. Zamot “evidenced ignorance about the recovery process in Puerto Rico, presenting incorrect figures relating to the existing conditions on the island,” adding: “I again invite the FOMB to collaborate so that the government of Puerto Rico, together with the support of the federal government, facilitates the fastest possible recovery of our island.” He noted that such assistance should not depend on the Board “assuming the administrative role” which belongs to the elected government of Puerto Rico.

Sanctioned Discrimination. The endorsement that the House Ways and Means Committee effectively incorporated in its “tax reform” legislation reported out of Committee this week appears to discriminate against Puerto Rico, imposing a tariff on the products which Puerto Rico exports to the mainland—threatening to deal a devastating blow to Puerto Rico’s industrial base at the very moment in time the territory is striving to recover from the already disparate hurricane recovery blows. According to economists Joaquín Villamil: “None of these measures, nor the repatriation of profits, the corporate rate and the 20% tax on imports is positive for the island…The companies are not going to pay a 4% royalty to Puerto Rico and a 20% tax to bring their product to the United States. They will leave the island, especially if the tax rate is lowered there.” Mr. Villamil added: “If that happens, 21% of the income received by the Puerto Rican Treasury is eliminated,” he added, referencing P.L. 154, the statute which established a 4% tax on sales of an operation in Puerto Rico to its parent company in the mainland. In its markup, yesterday, the House Ways and Means Committee left almost intact §4303 which establishes a 20% tariff on all imported goods for resale by companies and businesses in the United States. Moreover, the disposition forces multinationals with operations in places such as the U.S. territory of Puerto Rico to repatriate their income to the U.S. What that means is that the production of drugs, medical devices, and many other goods in Puerto Rico is done on U.S. soil; however, for federal tax purposes, Puerto Rico is deemed an international jurisdiction—or, as economist Luis Benítez notes: “This (House Ways and Means bill) generates greater uncertainty about what the economic future of the island should be: with this, the figure of the controlled foreign corporation (CFC) loses the competitive advantage it had (under §936).” He noted that by reducing the corporate rate to multinationals operating in Puerto Rico, the benefit of giving them tax exemptions at the local level is also reduced, as is the case of Law 73 on Industrial Incentives: via the elimination of §936, Puerto Rico, as a place to do business, went from competing with the continental U.S. to competing with countries such as Singapore and Ireland, adding that now a reduction in the corporate rate would cause Puerto Rico not only to compete with the rest of the world, but with jurisdictions on the mainland: “I think that if I were the Secretary of the Treasury, I would tremble with this situation.”

In Puerto Rico, he estimates manufacturing employs approximately 75,000 people directly—a number which rises to 250,000 when indirect and induced jobs are calculated, adding that even though the manufacturing sector has shrunk in the past years, the productive and contributory base rests on that activity, adding that: “As much as it is said that they do not pay taxes, this sector contributes 33% of the revenues…As long as jobs are lost there, the treasury will erode,” noting that the industrial sector plays such a large role in Puerto Rico’s economy that no other sector of the service economy can counterbalance it. He worries that if Congress fails to address the apparent discrimination, the chances that the PROMESA Board and the government of Puerto Rico can put together an economic recovery plan is minimal: “These are implications for all of Puerto Rico: It is difficult to think about options, because if this is approved, it would be disastrous, because of everything that has happened after Hurricane Maria.”

Last night, the former president of the Association of Certified Public Accountants, Kenneth Rivera Robles, who has been part of several lobbying delegations to Washington, remained relatively optimistic that the project language will be amended.

President Woodrow Wilson signed the Jones-Shafroth Act into law on March 2, 1917, with the law providing U.S. citizenship to Puerto Rico’s citizens, granting civil rights to its people, and separating the Executive, Judicial, and Legislative branches of its government. The statute created a locally elected bicameral legislature with a House and Senate—but retained authority for the Governor and the President of the United States to have the authority to veto any law passed by the legislature. In addition, the statute granted Congress the authority to override any action taken by the Puerto Rico legislature, as well as maintain control over fiscal and economic matters, including mail services, immigration, defense, and other basic governmental matters. 

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