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Does Puerto Rico <i>Really</i> Want to be the 51st State?

For the first time ever, a majority of the island's voters favor statehood. But while many think it's the answer to the territory's economic woes, others disagree.

01_1305_ Puerto Rico 126
It’s easy to feel like everything’s swell in San Juan. Driving through the neighborhoods of the Puerto Rican capital -- touristy Old San Juan, with its cobblestone streets and pastel colonial-era buildings; hip Condado, where designer boutiques and tony restaurants mix with beachfront hotels; even Río Piedras, a district of modern high-rises, bank headquarters and the local University of Puerto Rico campus -- you can forget that the island is in the throes of perhaps the worst economic catastrophe it’s ever seen. But you can’t forget it for long. Too many storefronts are permanently shuttered. Multistory buildings stand empty, with massive “for sale” banners faded by the sun and flapping in the breeze. Half-finished developments sit abandoned.

Puerto Rico’s economy is in crisis. The territory of 3.7 million residents is now in the seventh year of a persistent downturn, a recession that’s much deeper -- and broader -- than the one on the mainland. By a number of different indicators, Puerto Rico is off the charts compared to the rest of the U.S., faring far worse than any state. Per-capita income is one-third that of the nation as a whole and just half the income of the poorest state, Mississippi. Roughly 45 percent of Puerto Ricans live in poverty, three times the national rate. More than a third of the territory’s residents are on food stamps. Unemployment last year topped 15 percent.

Public finances are similarly abysmal. Fifteen straight years of budget deficits have ravaged the government; its outstanding public debt now hovers near $70 billion. (Relative to personal income, the debt level is nearly 10 times that of Hawaii, which has the highest debt-to-income ratio of the 50 states.) Puerto Rico’s public pension system has essentially run out of money, with an unfunded liability that is almost four times the island’s annual budget. By this past spring, all of the major credit agencies had downgraded Puerto Rico’s bond rating to one notch above junk status. Countless observers have dubbed the territory “America’s Greece.”

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Against that crumbling fiscal background, Puerto Rico has been shedding residents. Some 170,000 people (nearly 5 percent of the island’s population) have left in the past decade, in search of better opportunities in places like Texas, North Carolina and central Florida. Many are high-skilled workers; the number of doctors on the island has dropped 13 percent in just the past five years. Today more Puerto Ricans actually live in the 50 states than in Puerto Rico itself. An estimated 200,000 homes on the island stand empty. Crime, meanwhile, has surged. Thanks largely to a growing illegal drug trade, the island’s homicide rate is six times that of the U.S., putting Puerto Rico in league with places like the Congo and Sudan.

Puerto Rico is at an economic crossroads. But it may also be at a political one.

“For 40 years, Puerto Rico has been lagging and not performing as we should expect to,” says Pedro Pierluisi, the territory’s resident commissioner in Congress. “We haven’t progressed. We’re stagnating. We need a game-changer.”

That game-changer? For Pierluisi and many others, it is statehood. The benefits and drawbacks of U.S. statehood have been debated since the island came under American sovereignty more than a century ago. But in many ways, Puerto Rico has now moved closer to statehood than ever before. Last November, the island held its fourth-ever plebiscite, a nonbinding referendum on the island’s political status. For the first time, a majority of Puerto Rican voters opted in favor of becoming a state.

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Statehood advocates, of course, hailed it as a historic victory. Puerto Rico-born U.S. Rep. José Enrique Serrano of New York called the vote “an earthquake in Puerto Rican politics” and “a history-making moment.”

Others say the vote was far from decisive, in part because of how it was structured. The November plebiscite consisted of two parts. On the first question, 54 percent of voters said they wanted to change the island’s status. On the follow-up question, statehood won with 61 percent over other alternatives like independence or “sovereign free association,” which would grant more autonomy. But hundreds of thousands of voters left the second question blank, meaning actual support for statehood could be less than 50 percent. (In the days following the vote, one congressional aide told a newspaper that the 61 percent vote for statehood was seen by some congressional members as “statistical fiction.”) Adding to the confusion is the fact that, in the same election, voters ousted Gov. Luis Fortuño, an outspoken and highly visible statehood advocate. The White House has called for another plebiscite.

Still, the statehood faction is energized. In May, Pierluisi introduced a bill in Congress to admit Puerto Rico as a state. On the floor of the House, he said “the time has come” to add a Puerto Rican star “alongside the others, on the flag of the United States of America.”

Nothing divides Puerto Rico like the status question. Statehood advocates say the island’s stepchild commonwealth status is what’s holding it back and keeping the economy from flourishing. Technically speaking, the island is still an unincorporated organized territory, but it was also established as a commonwealth of the U.S. in 1952, when Puerto Rico ratified its own constitution. Its residents are U.S. citizens, but they cannot vote for the president and they don’t have voting representation in Congress. They’re exempt from many federal taxes, but they are protected by the U.S. armed forces and are part of the mainland judicial system.

Others say the commonwealth status is the very thing that will save Puerto Rico, and that statehood would thwart any hopes of economic growth. Statehood supporters describe Puerto Rico under its current status as an unstable dependency stuck in political and economic limbo, filled with residents being denied their constitutional rights to full citizenship. Commonwealth proponents portray it as a proud nation that could compete on its own in the global marketplace, if given the chance. Sometimes it’s hard to remember that they’re talking about the same place.

You can stand in one spot on the battlements of Castillo de San Cristóbal, the 350-year-old coastal fort that overlooks San Juan, and trace the entire economic history of Puerto Rico. Looking inland toward the mountains, you can see the verdant plots of land where plantations grew coffee and sugar in the 1800s, an abundant trade that would dominate the island’s economy well into the 20th century. Closer in are the factories and smokestacks of the heavy manufacturing industries that drove growth in the 1950s and ’60s. Sprinkled among them are the multinational petrochemical and pharmaceutical firms that arrived in the ’80s and ’90s. That progression from sugar to factories to medicines was actually a concerted economic strategy. But many people now say it’s the very reason for Puerto Rico’s current crisis.

The political and economic paths of Puerto Rico and the U.S. have been intertwined ever since the island was ceded to the States following the Spanish-American War of 1898. Puerto Ricans were granted citizenship in 1917. In 1948, the island elected its first governor; four years later, it ratified its own constitution. At that time, in an effort to shift the island’s economy from sugar to manufacturing, the federal government implemented Operation Bootstrap, a series of tax exemptions and tariff abatements -- along with the promise of cheap labor -- aimed at attracting factories to Puerto Rico.

For a while, it worked. Buoyed by the new investments -- and by the postwar boom years in general -- Puerto Rico’s economy grew steadily throughout the 1950s and ’60s. But as wages rose, companies on the island faced growing competition internationally, and the energy crisis in the 1970s threatened the local economy even further. So the federal government stepped in again, this time with a new tax provision: Section 936 of the tax code of the Internal Revenue Service, which allowed companies in Puerto Rico to earn profits on the island without paying federal taxes. For a while, that worked too. Chemical firms and pharmaceutical production factories flocked to San Juan. At one point, 14 of the 21 most popular medications in the world were made in Puerto Rico.

In the mid-’90s, things changed. President Bill Clinton and a balanced budget-minded Congress, looking to close tax loopholes, determined that Section 936 cost U.S. taxpayers $3 billion to $4 billion a year. They decided in 1996 to end Section 936, with a phaseout over 10 years.

“We lost the most important piece of our economic platform,” says Gustavo Velez, an economist who served as an adviser to two previous governors. By the time the phaseout was complete in 2006, Puerto Rico had lost more than 150,000 jobs. And the island, says Velez, still hadn’t figured out how to move its economy forward without the help of that “tax gimmick.” Today, he says, “we’re not in a recession, because a recession is cyclical. We are in a depression -- a structural economic problem. Our economy doesn’t have the capacity to build more activity or build new wealth.”

From the outside, Puerto Ricans may seem to have a pretty sweet deal. They don’t pay federal income taxes on anything they earn on the island, yet they still receive federal benefits such as Social Security and Medicare. Companies doing business there are still exempt from many corporate taxes, even after the end of Section 936.

But the reality, according to statehood advocates, is that Puerto Rico’s position as a commonwealth is no longer working. Uncertainty over the island’s permanent status keeps companies from wanting to locate there. “The current status has prevented us from maximizing the potential of the island,” says Carlos Colón de Armas, a finance professor at the University of Puerto Rico and a statehood supporter.

Even during the boom years, business growth did little to actually help the local economy, says Colón. Data he has analyzed show that while Puerto Rico’s gross domestic product (GDP) has risen over time, the gross national product (GNP) -- which measures local factors of the economy -- lagged further and further behind. In 1970, for instance, the GNP was 93.1 percent of the GDP. By 2012, that number had fallen to 68.8 percent. In other words, less of the money being generated on the island was actually staying there. “What we have now has not been good for the economy of Puerto Rico,” Colón says. “So for me, any alternative would be better than what we have.”

Figuring out whether Puerto Ricans would be better off under statehood is very difficult. True, their federal burden is very low compared to residents of any American state, but their state taxes are astronomically high compared to the rest of the U.S., since Puerto Rico is left to pay for more on its own. The lowest state income tax rate there is 7 percent, higher than in any of the 50 states. And the highest earners in Puerto Rico pay 33 percent -- three times Hawaii’s rate, which is the nation’s next highest. For federal programs like Social Security and Medicare, Puerto Ricans pay a full share but don’t receive nearly the level of federal benefits they would as citizens of a state.

Becoming a state, advocates say, would give Puerto Rico access to an extra $20 billion in federal funds every year. And even though residents would have to begin paying federal income taxes, the hope is that their wages and other assets would rise as companies began to view Puerto Rico as a politically stable place to invest. Meanwhile, the federal government would collect billions in new personal and corporate income taxes.

It’s simple, says Colón. If Puerto Rico’s current status were advantageous, the island would be thriving now. “If taxation were that big a problem, in terms of development, then Puerto Rico would be better off than the 50 states,” he says, because its federal taxes are lower. “And we are not. We’re not even catching up. Every one of the 50 states is better off economically than Puerto Rico. That’s probably the best argument in favor of statehood as an economic strategy.”

On a sunny Friday in May, Alberto Bacó Bagué isn’t thinking too much about statehood. Bacó is Puerto Rico’s new commerce and economic development secretary, appointed by Gov. Alejandro Javier García Padilla after he won election last November. The new administration doesn’t favor statehood and instead advocates addressing Puerto Rico’s economic challenges within its current status. That’s why Bacó and other economic leaders of García Padilla’s administration have gathered at a sprawling Sheraton hotel attached to San Juan’s modern convention center, its white swooping roof glinting in the sun. They’ve convened for the Puerto Rico Credit Conference, which offers a chance to show investors, creditors and bond-rating agencies that Puerto Rico is tackling its economic problems.

During a break from the conference, Bacó ticks through the measures enacted by the new administration so far: a pension overhaul that raises the retirement age and increases employee contributions while cutting benefits; a Jobs Now law offering energy credits, lease deals and other benefits for companies that create new employment opportunities; and a budget proposal that seeks new revenue by raising certain sales taxes. It’s an effort to take Puerto Rico back from the brink of insolvency, Bacó says. “But really what we need to do is ignite the employment creation and the wealth creation on the economic development side.”

How to accomplish that? By emphasizing the tax breaks and other incentives that Puerto Rico can offer precisely because it’s not a state. The government has recently expanded its corporate tax breaks to lure service firms and even wealthy individuals: New residents who move to Puerto Rico now will pay no local or federal taxes on capital gains. (The new law has sparked interest from a number of wealthy Americans including, reportedly, hedge fund billionaire John Paulson. In March, fevered speculation about a possible move to the island prompted Paulson, a lifelong New Yorker, to issue a statement saying he’s not planning to relocate.) Some say that trying to position Puerto Rico as a new Caribbean tax haven is a step in the wrong direction. But Bacó shrugs. “We got creative. We said, ‘Well, we’ve been giving tax incentives to corporations since the 1950s. Why not do it for new service companies? And why not also give that to individuals?’”

The only reason Puerto Rico can offer those kinds of breaks is because of its unique commonwealth status. And that’s vital to maintain, says Bacó. “We have good economic tools in place, and the only way those will be taken away is if we become a state.”

The island is becoming more active in seeking out new opportunities and working to attract new businesses, says Ingrid Vila Biaggi, Gov. García Padilla’s chief of staff. “In the past decade, Puerto Rico has really relied on waiting for things to happen. [The government] was not aware of the impact that globalization would have on Puerto Rico if we did not go out there and start looking for businesses. We’re going out there again. Now we’re not just waiting for companies to come here and knock on our door. We’re knocking on their doors.”

For the new administration and many others, the notion that statehood would fix Puerto Rico’s problems is an oversimplification. Statehood advocates tend to think that changing status will solve the island’s problems overnight, says Velez, the economist. “They see statehood as a magic solution.”

Ask Argeo Quiñones Pérez about the statehood argument and he starts singing a Traffic song. “It’s like ‘Dear Mr. Fantasy,’ like statehood means a shower of money from the federal government that is going to leave everybody happy,” says Quiñones, an economics professor at the University of Puerto Rico. “They think they’ll just sit in their house and the postman will bring money.”

The all-encompassing debate over status, say Quiñones and others, has itself become a major distraction from fixing the economic problems at hand. “The statehood thing really has become an obsession. Many people think that if we don’t solve the statehood issue, the other issues cannot be solved.” Meanwhile he says, time marches on, and the economy gets worse. “Are you going to just wait to fix the economy?”

Statehood advocates say the fiscal argument is on their side. But, they add, that’s not really the most important issue. What really matters to them is political rights. Puerto Rico is an island of 3.7 million American citizens who aren’t allowed to vote for the president and who don’t have voting representation in Congress. “We can talk about the economic questions,” says Colón, the finance professor. “But my argument is not economic. My argument is political. Puerto Ricans are subject to laws approved by a government in which we do not participate. And that’s a human rights issue.”

Every president since Harry Truman has said he would support Puerto Rico’s right of self-determination. (Ronald Reagan was an outright advocate for statehood.) Both the Democratic and Republican national platforms agree. In other words, if a majority of Puerto Ricans vote to become a state, they should become a state. Now, for the first time -- maybe -- they have cast that vote.

Still, the political prospects for statehood in the near future are slim. Puerto Rican voters are overwhelmingly Democratic, and even despite the statehood side’s claims that Puerto Rico has the makings of a swing state -- The voters are socially conservative! They’re strongly religious! -- it’s extremely unlikely that the current Republican majority in the U.S. House would admit such a blue-leaning state. And the pro-commonwealth position of the current gubernatorial administration will make the current statehood push even more of a long shot. For now, says Vila, the chief of staff, the focus is on fixing Puerto Rico’s economy without waiting for help from the feds. “For us, the status issue is an important issue, but it’s not the main issue. We need to improve the quality of life for the people of Puerto Rico, and that’s our first, second, third, sixth -- our top 20 priorities.”

But statehood supporters are undaunted. Puerto Rico needs “a stable, permanent status,” says Resident Commissioner Pierluisi. “The question is not whether Puerto Rico will become a state,” he says, “but when.”

Zach Patton -- Executive Editor. Zach joined GOVERNING as a staff writer in 2004. He received the 2011 Jesse H. Neal Award for Outstanding Journalism
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