Wednesday, December 7, 2016

Puerto Rico’s Decline

What Puerto Rico’s Failures Teach us About Economics

Economics are debated every day. No doubt, you have had disagreements with friends, coworkers or family members. This year has highlighted the major differences between the left and right, and when measured by historical examples, leftist policies aren’t simply inferiors; they are dangerous.

We’re going to use Puerto Rico as a running example of why the left view on economic policy is extremely dangerous. As quick history lesson for those who aren’t familiar, the Puerto Rican economy has been in shambles, and almost all of the decline has happened over the last ten years.

Minimum Wage
This has been a major battleground in politics this year, and protestors are still going strong. Minimum wage is not an inherently evil idea. Under-educated workers can and have been exploited by those in power, and a low-scale minimum wage can help prevent it from happening again.

The problem arises when the term “livable wage” starts to enter the conversation, mostly because the bottom “livable wage” varies wildly by region. Case in point, Puerto Rico is currently defaulting on tens of billions of dollars in debt, and their problems go back to minimum wage.

The island territory just can’t sustain the same base wages as the rest of the U.S., but they are still subject to federal minimums. When the rates went up in 2006, it started an epidemic of lost jobs that still plagues the territory. Of course, minimum wage is only the beginning.

Government Spending
Some facets of government spending are fairly universal. The big divide between the policies of the left and right mostly boil down to social programs. An easy example is education. Democrats want to increase education funding across the board, while the Republican policies tend to favor voucher systems that redistribute funding by merit, and this boils down the essence of the conflict: regulation vs competition.

Social spending is predicated on reasonable ideals. Provide education, healthcare, housing and jobs to every American, especially those with the least resources. While the principle is noble, much is often lost in execution. The primary problem is that welfare programs typically aim at subsidizing needs. They lead to indefinite financial commitments from the government.

Medicare and Medicaid are the most prominent examples. When this happens, it creates a perpetual strain on tax revenue that does little to promote general economic growth. These programs do put money into health care, but it’s so mired in bureaucracy that major medical companies can do little investing with the money they receive through those programs. It may keep the lights on at the hospital, but it has a lower impact on innovation and expansion, mostly because it creates stagnant income that fails to incentivize change. The right still promotes a large amount of government spending, but they usually argue to spend the money on more tangible results. Military contracts are almost solely dependent on innovation and are competitively renegotiated constantly.

Infrastructure is another big spending point, and it is the real difference maker. Infrastructure spending is ultimately a bunch of short-term investments. They put mobile money into construction industries, and the free markets are left to do the rest. Because contractors know that infrastructure jobs are temporary, they are forced to invest their gains competitively, and this drives markets forward.

Tax Revenue
The philosophy of spending is strongly mirrored in tax revenue. The left takes the direct approach: raising taxes raises tax revenue. This feels obvious, but the approach borders on simplistic. Combing back to our example of Puerto Rico, the root causes of the debt crises are really two-fold. While minimum wage was a huge problem, a second issue came in the form of corporate taxes.

In 2006, major corporate tax cuts expired. That drove many large businesses away from the island in search of more favorable conditions, and with them went thousands of jobs. That this problem coincided with the minimum wage hikes pretty much sealed the economy’s fate.

The companies that could have maintained higher wages left because multiple conditions were against them. To shorten a long story, declining job numbers cause a sharp decline in tax revenue, even though overall tax percentages were raised. It was unsustainable and the result was defaulting loans.

This example teaches an important less. Raising tax rates doesn’t always raise tax revenues. This is the core of the mantra of the right, and it is the foundation of Trump’s tax plans. Basically, short term revenue losses will happen when tax cuts hit the nation, but the resulting job, wage and profit growths stand to bring more long-term revenue than the tax hikes proposed by the left.

There’s another important, hidden message. The wealthiest Americans really do hold a large chunk of the nation’s wealth. The gut reaction is to think that they can afford to pay more in taxes, but again, the simplistic outlook is dangerous. In general, those holding wealth are not going to sacrifice their lifestyle to hire workers. Instead, disproportionate taxes will cause them to invest less and take fewer risks, ultimately hurting the entire economy. This is exactly what happened in Puerto Rico.

Regards, Ethan Warrick Editor Wealth Authority

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