Euro Pacific Capital, Inc., by Peter Schiff
While Greece is now dominating the debt default stage, the real tragedy is playing out much closer to home, with the downward spiral of Puerto Rico. As in Greece, the Puerto Rican economy has been destroyed by its participation in an unrealistic monetary system that it does not control and the failure of domestic politicians to confront their own insolvency. But the damage done to the Puerto Rican economy by the United States has been far more debilitating than whatever damage the European Union has inflicted on Greece. In fact, the lessons we should be learning in Puerto Rico, most notably how socialistic labor and tax policies can devastate an economy, should serve as a wake up call to those advocating prescribing the same for the mainland.
The U.S. has bombed the territory of Puerto Rico with five supposedly well-meaning, but economically devastating policies. It has:
- Exempted the Island’s government debt from all U.S. taxes in the Jones-Shaforth Act.
- Eliminated U.S. tax breaks for private sector investment with the expiration of section 936 of the U.S. Internal Revenue Code.
- Required the nation to abide by a restrictive trade arrangement.
- Made the Island subject to the U.S. minimum wage.
- Enabled Puerto Rico to offer generous welfare benefits relative to income.
While passage of such politically popular laws seems benign on the surface (and have allowed politicians to claim that their efforts have helped the poorest Puerto Ricans), in reality they have deepened the poverty of the very people the laws were supposedly designed to help. The lessons here are so obvious that only the most ardent supporters of government economic control can fail to comprehend them.
By exempting U.S. citizens from taxes on interest paid on Puerto Rican sovereign debt, Washington sought to help the Puerto Rican economy by making it easier and cheaper for the Island’s government to borrow from the mainland. As a result, Puerto Rican government bonds became a staple holding of many U.S. municipal bond funds. As with Fannie Mae and Freddie Mac bonds a decade ago, many investors believed that these Puerto Rican bonds had an implied U.S. government guarantee. This meant that the Puerto Rican government could borrow for far less than it could have without such a belief. However, this subsidy did not grow the Puerto Rican economy, but simply the size of the government, which had the perverse effect of stifling private sector growth.
In contrast to the tax-free income earned by Americans who buy Puerto Rican government bonds, those with the bad sense to lend to Puerto Rican businesses were taxed on the interest payments that they received. Businesses could have used the funds for actual capital investment (that could have increased the Island’s productivity), but instead the money flowed to the Government which used it to buy votes with generous public sector benefits that did nothing to grow the Island’s economy or put it in a better position to repay. That problem was left for future taxpayers who no politician seeking votes in the present cared about….
Read full article
Permission to republish granted by Euro Pacific-Peter Schiff. Creative Commons License.