By: Shu-Yi Oei
I’ve been following the story of Puerto Rico’s default on its public corporation debt repayment obligations, which has been unfolding over the last several months. The latest happened on Monday, May 2 (well, technically Sunday), when Puerto Rico missed a major debt payment that was due to the bondholders of its Government Development Bank (GDB).
The topic has been well covered from the sovereign debt/insolvency angle over on Credit Slips, so I won’t go into that in detail here. As I understand it, the main points are these:
(1) Puerto Rico owes around $70 billion total outstanding debt to its creditors, of which a significant chunk is public corporation debt. Public corporations are corporations owned by the government of Puerto Rico. For example, the GDB is a public corporation.
(2) Unlike U.S. municipalities such as Detroit, Puerto Rico entities aren’t considered debtors for purposes of Chapter 9 of the U.S. Bankruptcy Code. They therefore don’t have access to the Chapter 9 municipal bankruptcy process. See 11 U.S.C. § 101(52). This is a bit of a head scratcher.
(3) In 2014, Puerto Rico’s legislature passed a law, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, which created a mechanism analogous to Chapter 9 bankruptcy by which Puerto Rico public corporations can restructure their debt. See Puerto Rico Passes New Municipal Reorganization Act: Puerto Rico Public Corporation Debt Enforcement and Recovery Act, 2014 P.R. Laws Act. No. 71, 128 Harv. L. Rev. 1320 (2015).
(4) Some bondholders filed a lawsuit, contending that Chapter 9 of the U.S. Bankruptcy Code preempts the Recovery Act. The First Circuit ruled that the Recovery Act is preempted. Franklin California Tax-Free Trust v. Puerto Rico, 805 F.3d 322 (1st Cir. 2015). The Supreme Court granted cert and heard oral arguments on March 22, 2016. No decision yet. For one scholar’s take on the issue, see Stephen J. Lubben, Puerto Rico and the Bankruptcy Clause, 88 Am. Bankr. L.J. 553 (2014).
(5) In light of all this, some have called for U.S. Congressional action, and there’s been legislation drafted to address Puerto Rico’s fiscal crisis that will allow for both restructuring and reform going forward. The House Committee on Natural Resources put forth a draft bill, the Puerto Rico Oversight, Management & Economic Stability Act (“PROMESA”). See also here for a helpful executive summary that accompanied an earlier draft. So far, that legislation has stalled, but they’re still trying.
There are many important issues in play, about which various stakeholders and commentators disagree. Some big ones are: (a) whether the draft PROMESA legislation raises retroactivity issues that make it unfair to bondholders (including mutual funds and their investors) who may be subject to restructuring ex post without having had notice of that possibility ex ante; (b) relatedly, whether creating a bankruptcy-like restructuring process for Puerto Rico is bad for bondholders because it prevents holdout creditors from holding up restructuring negotiations, (c) how much oversight and sovereignty Puerto Rico should cede (for example, different stakeholders feel differently about the installation of an oversight board); (d) the extent to which austerity measures are feasible and should be imposed [fn1], and (d) and what substantive reforms should be put enacted going forward.
So where does tax come in?
The answer is, of course, pretty much everywhere. I don’t think it’s possible to get an accurate picture of Puerto Rico’s fiscal situation without understanding how U.S. and Puerto Rico tax policy decisions have interacted with decisions about public sector debt financing. Relatedly, the historical narrative one tells about how things got to where they are (including the tax and public finance backstory and the U.S.’s role in that backstory) will frame the types of policy choices one finds palatable going forward. [fn2] And finally, it’s important to understand the effects of various tax laws and policies on Puerto Rico’s economy and its fiscal condition.
So, anyway, here are some interesting materials on the tax aspects of the Puerto Rico fiscal crisis.
First, Diane Dick at Seattle University School of Law has a fascinating article up on SSRN, U.S. Tax Imperialism in Puerto Rico (forthcoming Am. U. L. Rev.). I have a JOTWELL review of it coming out shortly, so I won’t say too much more about it here. Basically, the article puts forth a theory of U.S. tax imperialism in Puerto Rico since 1898, detailing the ways in which U.S. tax policy has been used to control the economic trajectory of the territory for the benefit of the mainland for over a hundred years. The article provides a counter story to a popular narrative, which is that Puerto Rico’s debt crisis is a result of its own fiscal irresponsibility.
Second, there’s a couple of short posts up at the Tax Foundation and Tax Policy Center blogs from June and July 2015. From the Tax Foundation, see Scott Greenberg & Gavin Ekins, “Tax Policy Helped Create Puerto Rico’s Fiscal Crisis.” That post discusses three tax policy features that contributed to the crisis: The repeal of the Section 936 possessions tax credit and its recessionary effects, the creation by the U.S. Congress of “triple tax exempt status” for Puerto Rico’s bonds (which led to excessive issuances), and Puerto Rico’s own ill-advised tax breaks for corporations in certain industries. From the Tax Policy Center, see Tracy Gordon, “Puerto Rico: Not your Father’s Debt Crisis—or Your Greek Uncle’s.” That post points to the Section 936 repeal and the triple tax exempt status of Puerto Rico’s bonds as well, and it also discusses Puerto Rico’s creation of a Value Added Tax to raise revenue as part of its Act 72 of 2015.
More generally, it’s worth looking at the tax changes made in Puerto Rico’s Act 72 of 2015, which contains some measures designed to raise revenue. For a pithy summary, see here. In addition to the VAT, the Act increased the rates for the Puerto Rico corporate AMT’s tangible property tax, with a new top rate of 6.5%. This “Wal-Mart Tax”—so called because the top rate only applied to Wal-Mart Puerto Rico—is actually a tax on certain related-party personal property transactions between Puerto Rico taxpayers and related parties outside Puerto Rico. Wal-Mart Puerto Rico appealed, and on March 28, 2016, the United States District Court for the District of Puerto Rico ruled in that the tax violated the U.S. Constitution and the Federal Relations Act. Wal-Mart Puerto Rico v. Zaragoza-Gomez., Civil No. 3:15-CV-03018 (JAF). The District Court opinion noted the urgent need for revenue raising in Puerto Rico, but struck down the tax anyway. The case has been appealed to the First Circuit. Wal-Mart Puerto Rico, Inc. v. Zaragoza-Gomez, Docket No. 16-01406 (1st Cir. Apr 15, 2016).
Tax law and policy choices are an important aspect of sovereign debt and municipal bankruptcy and restructuring. Such tax choices can play an obvious role in explaining, causing, or alleviating the fiscal distress experienced by municipalities, sovereigns, states, and territories. I’ll be blogging more about tax-related developments as they occur. Meanwhile, if others have suggestions for further reading, feel free to add them in the comments section.
[fn1] For example, the Democratic Staff of the House Committee on Natural Resources issued a report on May 4, 2016, expressing concern about the impact of further austerity measures on the public health system in light of the Zika virus outbreak.
[fn2] For a general analysis that looks at both tax and non-tax factors, see Marc D. Joffe & Jesse Martinez, Origins of the Puerto Rico Fiscal Crisis, Mercatus Center George Mason University (April 2016).