STUMP » Articles » Public Finance Quick Takes: Thanks to Sources! Puerto Rico, Chicago, and Cigarette Taxes » 7 August 2015, 07:16

Where Stu & MP spout off about everything.

Public Finance Quick Takes: Thanks to Sources! Puerto Rico, Chicago, and Cigarette Taxes  


7 August 2015, 07:16

In response to my Puerto Rico defaults post, somebody emailed me to let me know that the bill to allow for bankruptcy was not as the Washington Post characterized it. (I will remark below)

While I do not allow comments on this blog (I have read said comments at other public pensions-related sites and don’t want to be having to moderate that stuff. I do have a couple of paying jobs, you know.), I am very happy for people to email me. The info is on the about page, but for convenience, here it is: My twitter handle is meepbobeep (2 bs, 2ps) — email is a better way to contact me than @ing me on twitter, though.

Some of the links/topics come via people who email me, and I am especially interested in being corrected when something is wrong.

Thanks to my top referrers:

As well as my retweeters, and whoever was searching on “damnedmary”. Not sure what that was about, but it landed them here.


First, a NY Times piece on even worse cash flow pressures to come, and some specific dates to watch:

While Puerto Rico’s first bond default in its history reverberated through the financial markets on Tuesday, another move by the cash-poor island may provide a clue to where the next trouble spot lies.

After openly acknowledging on Monday afternoon that it had not made a $58 million bond payment, the government quietly disclosed in a financial filing later that afternoon that it had temporarily stopped making contributions of $92 million a month into a fund that is used to make payments on an additional $13 billion in bond debt. A small payment from the fund is due on Sept. 1.

Unlike the bond payments that went into default on Monday, the ones coming due are on general obligation bonds — the kind many investors have been led to believe would never go into default because the issuer’s full faith, credit and taxing authority stand behind them.

Puerto Rico issued such bonds over the years to raise money for a variety of government projects, and investors bought them eagerly because the island’s constitution explicitly guaranteed that such bonds would be paid.

The general obligation payment due to bondholders on Sept. 1 is for a mere $5 million, an amount so small that even if the redemption fund is empty at that point, Puerto Rico could still produce the cash right out of general revenue. It would presumably want to do so because of the constitutional requirement.

But a much bigger payment on the general obligation bonds, about $370 million, comes due on Jan. 1.

If Puerto Rico misses that one, “it would be an earthquake for the markets,” said Matt Fabian, a partner at Municipal Market Analytics, a financial research firm.

“Defaulting on the Public Finance Corporation bonds was a change in direction,” he said, referring to the government unit whose bonds have been in default since Monday. “Defaulting on the general obligation bonds would change the game entirely.”

The Public Finance Corporation issues what is known as a moral obligation bond — a type of bond that gives investors little recourse in the event of a default, and the financial institutions that hold the debt still appeared to be assessing their options — including possible lawsuits over the default — on Tuesday. Puerto Rico bonds continued their long, steady decline on Tuesday.

Around the time the budget was being completed, something else happened that now seems portentous, even though few noticed it at the time: A 1976 law was amended, allowing Puerto Rico to stop making monthly prepayments on general obligation bonds. The suspension took effect in the 2016 fiscal year, which began on July 1.

When Mr. Fabian heard about the amendment he called it “most alarming” in a newsletter his firm publishes. True, the amendment meant only that Puerto Rico would stop putting the bond prepayments into something like an escrow account. But it also meant that when Jan. 1 rolls around, $370 million will be due to the general obligation bondholders and unless something changes in the meantime, the money will not be there.

The bill now before Congress, to give Puerto Rico limited access to bankruptcy court, might produce that outcome. It would let Puerto Rico send a few of its big public enterprises, which issue revenue bonds, to be restructured in bankruptcy. The general obligation bonds would presumably be untouched.

But the bill has not progressed. Republicans and Democrats alike are deeply divided over whether to help Puerto Rico — and even how. In the meantime, plans for restructuring the island’s entire $72 billion debt are being devised by a working group established by the governor. The deadline for the plan is also Sept. 1.

So the next big date is September 1, but the next real big date is January 1, 2016.

But what about these bills on bankruptcy?

Washington, DC—Senator Richard Blumenthal of Connecticut and Senator Charles Schumer of New York, along with 10 other U.S. Senators, today filed an identical companion bill to H.R. 870, the Puerto Rico Chapter 9 Uniformity Act, which was introduced by Resident Commissioner Pedro Pierluisi on February 11, 2015 and was the subject of a hearing before a subcommittee of the House Judiciary Committee on February 26th.

The Senate bill is S. 1774.

Other original cosponsors of the Senate measure include Senator Harry Reid of Nevada, Senator Kirsten Gillibrand of New York, Senator Bill Nelson of Florida, Senators Robert Menendez and Cory Booker of New Jersey, Senator Elizabeth Warren of Massachusetts, Senator Martin Heinrich of New Mexico, Senator Christopher Murphy of Connecticut, Senator Bernie Sanders of Vermont, and Senator Mazie Hirono of Hawaii. It is expected that the number of senators cosponsoring the legislation will increase in the coming days.

The bill introduced in the Senate today, like the bill filed by the Resident Commissioner in February, seeks state-like treatment for Puerto Rico under Chapter 9 of the federal Bankruptcy Code, nothing more and nothing less. Through Chapter 9, Congress has empowered each state government to authorize a “municipality” within the state to adjust its debts under the supervision of a federal bankruptcy judge based on federal substantive and procedural law. A state government may authorize—or decline to authorize—its insolvent municipalities to file for Chapter 9 protection. The power to decide rests with the state government. Puerto Rico is treated like a state in every chapter of the Bankruptcy Code except for Chapter 9. Between 1938 and 1984, judges and scholars generally agree that Puerto Rico did have the power to authorize its municipalities to adjust their debts. However, in 1984, Congress enacted legislation that expressly excluded Puerto Rico from Chapter 9. As a federal appeals court recently noted, the legislative history offers no indication why Puerto Rico was excluded.

Puerto Rico’s exclusion from Chapter 9 led the territory’s government, in July 2014, to enact local legislation called the “Puerto Rico Public Corporation Debt Enforcement and Recovery Act.” The Recovery Act sought to authorize certain Puerto Rico public corporations to adjust their debts. Multiple investment firms that own PREPA bonds sued the Puerto Rico government, arguing that the Recovery Act—which differs from Chapter 9 in multiple respects—violates the U.S. Constitution. On February 6, 2015, a federal district court judge in Puerto Rico held that the Recovery Act is preempted by the U.S. Bankruptcy Code and is therefore invalid under the Supremacy Clause of the Constitution. On July 6, 2015, the U.S. Court of Appeals for the First Circuit affirmed the district court’s decision. The appeals court concluded that “Congress preserved to itself that power to authorize Puerto Rican municipalities to seek Chapter 9 relief.” According to the court, Puerto Rico’s only option is to “turn to Congress for recourse.”

To make this clear: it’s not that Puerto Rico itself would go through Chapter 9 bankruptcy as an entity, but sub-entities (like PREPA) could use the municipal bankruptcy process.

I just wanted to point out a comment from that court ruling:

As the First Circuit Court of Appeals observed in a recent decision, the legislative history does not reveal why Puerto Rico was excluded. One of the judges described it rather poetically: “[T]here is no legislative record on which to rely for determining Congress’s reasons behind the 1984 Amendments. A tracing of its travels through the halls of Congress sheds less light than a piece of coal on a moonless night regarding the reason for its enactment.”

How very poetic.

By the way, there are all sorts of limitations on Puerto Rico. Partly because it’s not a state (just as Washington, DC is not a state, though DC is a different kind of entity), but some of the restrictions are questionable payoffs to very specific interests:

The most unfair law of all is the Merchant Marine Act of 1920, also known as the Jones Act, which requires that every product that enters or leaves Puerto Rico — cars from Japan, engines from Germany, food from South America, medicine from Canada — must be carried on a United States ship.

A foreign-flagged vessel may directly enter Puerto Rico — but only after paying taxes, customs and import fees that often double the price of the goods it carries.

This is not a business model. It is a shakedown, a form of legalized price-fixing, the maritime version of a protection racket. From 1970 through 2010, the Jones Act cost Puerto Rico $29 billion.

If the Jones Act did not exist, neither would the island’s debt, and tens of thousands of maritime jobs would shift to the island from Jacksonville, Fla., where the giant carriers Crowley, Horizon Lines and Sea Star Line conduct their offloading and reloading for shipment to Puerto Rico.
The island’s Legislature has done what creditors and bond rating agencies have demanded: Since 2010, it has laid off workers; raised prices for water, gasoline and electricity; increased property, sales and small-business taxes; cut public pensions and health benefits; raised the retirement age; and closed schools.

No surprise that over the past 10 years, nearly 400,000 Puerto Ricans have moved, many to Central Florida. With a shrinking tax base, Puerto Ricans are unable to meet this burden. Gov. Alejandro García Padilla calls it a “death spiral.”

What can be done? The Jones Act must be repealed, right away. Congress will have to overcome opposition from lobbyists for the Jacksonville-based carrier companies that control trade to the island.

Consider that we don’t require all the goods coming into Washington DC come via U.S. carriers. There is no reason we should be imposing a mercantilist policy on Puerto Rico, one of the bad ideas of European imperialism that had died a century before the U.S. took over PR.


This story isn’t exactly about pensions or bankruptcy, but desperation of state governments to find revenue, and shooting their feet in the process:

Facing a massive budget deficit this spring, Kansas Gov. Sam Brownback turned to an unexpected source to help raise much-needed revenue: a nearly threefold increase in the state’s 79-cent-per-pack cigarette tax. But lawmakers resisted, instead approving a budget with a more modest cigarette tax hike of 50 cents.

Legislatures increase cigarette taxes periodically for a variety of reasons. Policymakers and public health advocates have long pushed them as a means to incentivize smokers to quit. More recently, though, a number of states have looked to them to bridge sizable budget gaps. When governors unveiled their budget proposals earlier this year, nine included proposals to raise taxes on tobacco.

One of those states was Louisiana, which used a 50-cent tax increase on cigarette packs to help close a $1.6 billion budget shortfall. Lawmakers also introduced new taxes on electronic and vapor-based tobacco products to help minimize Medicaid funding cuts. In Ohio, Gov. John Kasich initially proposed raising the state’s cigarette tax by $1 per pack before lawmakers approved a budget with a 35-cent increase. Nevada lawmakers passed a $1 per pack tax increase in Gov. Brian Sandoval’s $7.4 billion budget, helping pay for additional investments in education. Lawmakers in Connecticut, Rhode Island and Vermont OK’d smaller cigarette tax hikes as well.

The extent to which states rely on cigarette taxes for revenue, while not significant, varies greatly. Cigarette taxes accounted for 9.4 percent of New Hampshire’s total tax receipts in fiscal year 2014, the most of any state. This is partly because New Hampshire lacks a broad-based sales or individual income tax, but also because the state benefits from cross-border purchases by smokers living in neighboring states with higher tax rates.

In the long term, cigarette taxes represent a less-than-ideal revenue source, because the money they bring in is gradually declining. An analysis by the Government Accountability Office estimated Americans consumed 299 billion cigarettes in 2010, down from 456 billion in 2000. “If you’re depending on cigarette revenue for education, you better be thinking about the years down the road,” says Norton Francis, a researcher with the Urban-Brookings Tax Policy Center.

Part of the problem, of course, is that fewer and fewer people smoke (especially as old smokers die, which they do much sooner than non-smokers), which means trying to gain more revenue by increasing the tax rate… which pushes more people to quit. Reminds me of when more people go to hybrid vehicles and then see gas taxes raised further (or talk of trying to tax miles driven).

Sometimes, I’m suspicious that anti-vaping laws are not because governments want to fight nicotine dependency, but that they’re afraid of losing the cigarette tax revenue.

Given that NY has the highest cigarette tax in the states (which is directly related to the black market in cigarettes here), it’s not surprising to me it was one of the first out of the gate with anti-vaping legislation.


Mark Glennon asks if Chicago is crazy:

Is some form of madness behind the response of Chicago and Cook County to the death spiral they are in? Let’s first look at the headlines from just this past week because, like Alice, you may quickly find six crazy things you’ll have to accept:

– Two weeks after raising Cook County’s sales tax to the highest in the country, it’s now considering a pay increase of $130 million over five years.

– Chicago may authorize “capital appreciation bonds” that, like a negative mortgage, would push principal and interest payments off until later, an idea rejected by Puerto Rice as being too risky and too expensive.

– Chicago released numbers showing it faces a $426 million dollar budget deficit, but that’s based on rosy assumptions, including the almost certainly false hope that it will get pension reforms it wants, so the real deficit is likely over $1 billion.

– No ideas emerged on how Chicago can fund a primary obligation of any modern government — schools.

– Detroit is trading places with Chicago on credit ratings. The raters began upgrading Detroit to investment grade while Chicago sinks further into junk status.

– Senate President John Cullerton went before the Chicago Tribune editorial board and stuck to his position that things aren’t as bad as reported. House Speaker Michael Madigan wrote an op-ed with the usual claim that his leadership is best for the poor and middle class. They are responsible for most of the pension, tax and other primary laws that have bound Chicago for decades.

Maybe it’s just a routine matter of what shrinks call “cognitive dissonance.” The starting point on that theory would be a fact that’s hard to deny rationally — that our model of government in Illinois is broken. We simply aren’t generating the jobs, revenue and growth we need to meet promises made. Try saying it just that way to a traditional Illinois politician, like pretty much every officeholder from Cook County. I have, including to some legislative leaders. You don’t really get disagreement. You get a blank stare. They can’t directly deny it. How could they?

Until the crash actually occurs, many people won’t believe that it can actually happen.

This is not just a governmental issue, but occurs all over human life.

Think of the alcoholics who do not get treated until they hit rock bottom. As you say, they wouldn’t be raising expenditures if they were taking this seriously.

I’m sorry, Mark, but Chicago and Illinois have yet to hit rock bottom. I hope it’s not too destructive when they do.

There is hope in the form of Detroit, by the way:

If current trends mean anything, it looks like Detroit and Chicago are trading places – at least financially.

On July 29, Detroit received an investment grade rating from Standard & Poor’s Ratings Services on a $245 million bond issue, just seven months after the Motor City exited from the nation’s largest-ever federal bankruptcy.

Chicago, on the other hand, is headed in the opposite direction. The city’s credit rating is in junk-bond territory after a series of recent downgrades. And it seems more downgrades are on the way.

Chicagoans may take solace in the fact that Detroit still has a long way to go before it’s out of the woods. The city’s $245 million bond issue received an investment-grade rating only because the income-tax revenue backing the bond will bypass city coffers and go directly to the bondholders. The city’s overall credit is still rated in junk bond territory at “B” – well below investment grade. But that’s still higher than its previous rating of “C.”

After nearly two years of restructuring, Detroit has good news that’s driving its ratings higher. The city’s revenue has been rising for the past four years and it’s finally balancing its budget, according to city officials.

The linked post says that pension reform is needed (I agree), but it goes beyond the need for pension reform. There needs to be real spending reform, across the board, and more “holidays” and borrowing won’t get that in order.

It would help if the union lobbyists weren’t given public goodies themselves. Teachers pensions are a big fiscal overhang.

But it’s not the only one — I’ve been trying to round up all the Chicago/Cook County pensions, to try to get a numerical handle on them, and I’ve got about ten or eleven so far. I don’t think it ended up as bad as Detroit, which had a one-man union, but it does make it difficult to do a good analysis as to the overall pension impact.

Anyway, the threat of bankruptcy should be in the mix. But until people come up against the reality that everybody is going to get cut, even them, they will not negotiate downward.

And the crash will come, especially if they deny it is coming.

Related Posts
Taxing Tuesday: The Money Goes Away
Taxing Tuesday: Let's Tax the Rich in NY! It Will Really Work This Time!
Taxing Tuesday: Our Clever Ideas are Totally Going to Work! Please Billionaires, Don't Leave!