The V.I. government is at a crossroads. Along with this year’s $110 million deficit, the USVI is facing ongoing structural deficits of around $170 million per year out of a locally funded budget of around $850 million. It has outstanding debt of more than $2 billion, not counting the debts of the government-owned Water and Power Authority, which is also struggling financially. It has a $3 billion unfunded pension liability with the pension system projecting it will cease being able to pay full pensions by 2023. And for the first time, after two rounds of ratings downgrades in less than a year, lenders have refused to buy V.I. government bonds, making it very difficult to smooth over the gaps.
As the noose tightens, the government has stopped putting money into its pension system – a system that was already projected to stop being able to make full pension payments in just a few short years. It has reduced payments to vendors, putting basic functions at its landfills at risk, stopped paying income tax refunds, held back income tax refunds, chronically underpaid on its utility bills. The V.I. Police Department has drastically cut overtime.
About the only things not under consideration are for the governor or commissioners to take a cut in pay, or for the governor to stay someplace cheaper than the Ritz Carlton, which Gov. Kenneth Mapp has vehemently and indignantly rejected. (See: Mapp Announces More Potential V.I. Austerity Measures in Related Links)
Some financial analysts have begun to express concern the territory is not on a sustainable path and will eventually have to restructure its debt. Ratings agencies have downgraded V.I. debt twice in the past year. The debt is the total amount of outstanding borrowing, while the deficit is the annual shortfall. If the deficit can be eliminated the debt will take care of itself in time.
Wednesday, March 22, Gov. Kenneth Mapp signed tax increases on beer, liquor, sodas and timeshare rentals aimed at reducing the structural deficit and reassuring bond markets the territory is on the right track.
How did we get here and what can we do about it? If you ask a Virgin Islander on the street, you may hear about government waste, officials living high on the hog and a bloated bureaucracy. Some point to the closure of the Hovensa refinery and its impact on revenues. Is that it? Mapp administration officials often emphasize a large increase in total V.I. government indebtedness over the past decade, seeming to point the finger at the previous administration of Mapp rival Gov. John deJongh Jr. What is the truth?
To try to get a clear and direct look at the territory’s finances and budget history over time, without the filter of potentially biased political officials, the Source compiled data on the territory’s revenue, spending and borrowing since the 1980s. We looked at the executive budgets submitted from 2004 through 2017, which also include historical information. We looked at bond offerings from the 1990s to now, which contain debt and revenue information too. Some data came directly from the federal government. Some came from the V.I. Public Finance Authority.
Part 1: How Did We Get Here?
Budget Director Nellon Bowry told senators in 2015 that deficits have plagued the government for at least the last 20 years.
“Left unattended, this annual deficit has morphed from a manageable $9.2 million as recently as FY 2006 to a fiscally frightening peak of $577.6 million in FY 2010. Accelerated first by the Great Recession of 2008 and later by the closing of Hovensa refinery, the accumulated General Fund deficiency for the five fiscal years between FY 2008 and FY 2013 totaled approximately $1.5 billion; an annual average of almost $300 million. The root causes of this structural imbalance have not been proactively addressed. Rather, the annual shortfalls have been financed by ad hoc combinations of inter-fund transfers and by formal and informal debt,” Bowry said in 2015.
The data largely back Bowry up.
See Figure 1: V.I. Government Debt and Revenues, 1991-2016
But debts did not begin in 2006 and there have been large deficits before 2006 too. That increase was largely a continuation of a long-term trend. Debt also doubled in the previous eight years, from $530.5 million in 1998 to $1.1 billion in 2006.
While that debt increase occurred during a period of relative economic calm, federal actions affecting the territory’s V.I. Economic Development Authority’s tax break program had the effect of reducing local tax revenues.
In 2004, the Treasury Department and IRS cracked down on the EDA program, starting with Treasury changing its rules and mandating tax-break recipients live in the USVI at least 183 days. Later that year, Congress codified the change in a section of the American Jobs Creation Act.
Prosecutions of several people with Kapok Management for tax evasion and the changes in rules discouraged financial firms and others from seeking V.I. Economic Development Authority tax breaks. Those companies account for as much as 25 percent of all local tax revenue, mostly from employee income tax. From 1999 to 2009, companies getting tax breaks accounted for an average of $91 million per year and in 2004, The Economic Development Commission is the arm of the EDA that gives out tax breaks. EDC recipient employees paid $119 million in income taxes. Revenues dropped off some after the 2004 federal tightening of rules, although the impact is difficult to measure.
There were 66 EDC tax break recipients in 1999; 97 in 2003, then a sharp drop off, slowly rising back to 66 in early 2016. Some former top V.I. government officials have said, on background, that these changes may have cost the V.I. treasury hundreds of millions of dollars over the course of five or six years. But the conclusion that there were very high losses hinges on the unprovable assumption of ongoing rapid growth in EDC employment in the years after the changes. As Figure 1 shows, local tax revenues increased steadily from 2004 through 2008, undercutting the notion that EDC changes are a major culprit for V.I. budgetary woes during that period. The U.S. recession in 2001 appears to have had a vastly larger impact on V.I. revenues than changes to IRS rules in 2004.
Mapp hopes to increase EDC revenues by $40 million per year over the next five years by selling more companies on the tax break program, but it is not clear if that level of growth is realistic.
In 2012, the USVI reduced hiring requirements from 10 employees to five, reducing the impact of each new EDC tax break recipient. And a number of the EDC companies are pre-existing local hotels, shopping malls and such, whose employees were already paying taxes before the parent companies were given tax breaks.
Looking at the chart again, you can see a sharp rise in debt occurring about the same time as a sharp – and permanent – decline in revenues starting in 2009, shortly after the 2008 financial collapse. Then-Gov. John deJongh Jr. spoke about the decline in revenues at the time and his administration borrowed in hopes of generating economic stimulus through capital projects and for working capital.
As deJongh defended a plan for borrowing in his January 2010 State of the Territory Address, he said the government had $234 million fewer dollars to spend over the previous fiscal year than the year before.
“To put this in perspective, $234 million is almost half of the cost of salaries and benefits of our government workers for a full year,” he said.
In May 2010, the news was not better and deJongh said in a radio address the government needs about $1.3 billion a year to function, but had collected only about $759 million – a half-billion dollar shortfall. He said revenues – including taxes, fees and fund contributions were down 27 percent. He pushed for a large bond bill, saying the alternative would be to lay off personnel, which would hurt schools and government services and be self defeating by reducing payroll taxes and multiplier effects from the personal spending of government employees in the V.I. economy.
“Unfortunately, for some this has caused a misguided opportunity to spread misinformation in many quarters where people are stating that we do not have a real financial crisis or that we can somehow afford to lower the demands for government funds by just sending people home,” deJongh said that year, criticizing senators who questioned his motives and truthfulness in saying there was a crisis.
“Home where? Who will pay for their health care, their housing, their food? And how do we make up the approximately $2.5 million that is spent locally each week by our government workers in our local stores and businesses? We cannot delude ourselves that there is a separation between the well being of our government workers and our private workers. If the former are out of work, the latter will soon follow,” he said.
So the government embarked on what everyone hoped would be short-term borrowing, to keep the economy afloat until revenues returned to normal.
But revenues did not return to normal.
Next: Part 2: The Elephant in the Room –Hovensa’s Closure