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Economic Development and Development Incentives Discussion Paper: US Virgin Islands

July 15, 2014 – Under The Markets Admin

Objective
Spur economic growth in the Territory of the Virgin Islands through government provided development incentives.

Relevance
The overall economic profile of the Territory is troubling. In 2012, the Territory’s GDP fell 13% and over 4,000 jobs were lost. The drivers behind this decline were the worldwide recession and the closure of the HOVENSA refinery.

The Virgin Islands Economic Stability Act of 2011 reduced the salaries of all government employees by 8% and impacted household income and discretionary spending. This further accelerated the economic slowdown in the Virgin Islands.

Government borrowing to pay operating expenses and the continuing sluggish economic recovery requires a renewed focus on strategies, programs and new initiatives to encourage new business growth, strengthen existing businesses, create and retain jobs, and attract outside investment.

Present Status:

Gross Receipts Tax (GRT) receipts increased from 4.5% to 5% six months into fiscal year 2012 and resulted in a 1.7% growth in cash-basis collections in 20131. Revenues from the GRT were forecast to increase by 1.9% in fiscal year 2014, but through the first half of 2014 revenues were down 7.4% year-over-year. This evidenced a continued slow down in commercial activity. Undoubtedly, the increase in the tax rate also impacted economic activity and the associated revenue receipts. The Government now has fewer resources available for operating expenses as well as to invest in new economic development initiatives.

Fitch Investors Service reviewed the credit of a recent Public Finance Authority financing. That agency’s comments are capsulized below.

The overall rating outlook of the Territory continued to be negative. More alarming, however, are the economic challenges facing the Territory. The Territory will continue to face challenges to solidifying and diversifying its economic base because of “limited flexibility” to respond to the recent economic downtown, the HOVENSA closure, and a tourism sector that is demonstrating “uneven growth”. New businesses that emerge as a result of economic development efforts can, however, ensure a less volatile economic profile for the Territory.

Key Definitions:

• Privatization – The process of transferring the responsibility of an enterprise or industry from the public sector to the private sector.
• Seed Investing – The initial capital needed to grow a business. These funds can be obtained from a variety of sources, and are usually intended to cover operating and capital expenses until the business has achieved a level of success where it is capable of generating sufficient revenues for ongoing operations. This initial stage of investing is the most uncertain with the highest risk and is not appropriate for government investing. Government support is most effective when it supports expanding market reach for existing businesses.
• Monetize – The conversion of an investment or asset into cash or a revenue stream. Government, seeking to spur private investing and/or introduce private management practices, may sell assets to the private sector to achieve either of these objectives.
• Public Private Partnerships – A business agreement between a private- sector company and a government agency for the purpose of completing a project that will serve the public good and economic growth. These projects are generally large in scale. The private party assumes substantial financial, technical and operating (management) risk. The government provides assets, infrastructure, and possibly some equity financing. By Agreement, the public and private parties share in the initiative’s economic return.
• Participating Lease- Rights to the use of a real estate asset is transferred for an extended period when the use of that asset contributes to the success of a development initiative. The lessor may reduce the required payments, skip or defer payments until the project is economically viable. Once the project is economically viable, the lessor receives the negotiated rent, previously deferred payments and participates in the financial success of the project through a “participation interest” or royalty negotiated at the time of the original agreement.

Approaches:

• The VI Government can invest in private sector driven economic development by providing various incentives and stimuli. Stimulus is the providing of incentives or benefits (i.e., tax savings, grants, labor training, land, infrastructure development, financing, etc.) desired by the private party for a certain timeframe. These can be individually allocated or bundled in an effort to fashion a compelling argument for a moving forward with an investment. The key is to provide just enough incentives as is needed to support the investment and to phase out those incentives once the investment no longer required that support.
• Streamline the business registration process and couple this with an intergovernmental council of relevant agencies that address impediments to business formation, attraction and growth when obstacles are identified.
• Leverage federal assistance (i.e., New Market Tax Credits, Low Income Housing Tax Credits, energy rebates, community development assistance grants and funding, etc.) to supplement local financial resources.
• Encourage public private partnerships, which heightens the economic attractiveness of projects to local or foreign private investment.
• Privatize certain services provided by government, which has the potential to generate economic and other development benefits. Derivable benefits include:
  • Government reduces its size and impact on the economy.
  • Private sector job creation is advanced and new opportunities created for employment.
  • Tax revenue is increased.
  • A more resilient, diverse and flexible economy is created that is better poised to weather stresses and changes in consumer demand.
  • There is an improvement in service as competition is introduced which creates economies of operation, is more responsive to consumer needs and demands, and produces a lower cost of service.

Reasons for Timely Action:

• Globalization and competition.
• The imperative of diversifying the economic base of the Virgin Islands. Today, the primary supports for the Virgin Islands economy are rum production and exports, tourism, and government transfer payments. The rum distilling and tourism sectors are seriously exposed to consumer discretionary spending preferences. The economy must be better positioned to absorb shocks, a lesson learned from the recent HOVENSA closure and the Great Recession.
• The need to spark employment growth and employment opportunity.
• The need for additional revenues to allow for a more stable fiscal operating environment for the VI Government.
• The need for more efficient and effective government services.
• The demand for more appropriately allocated financial resources to address pressing societal demands in education, health, public safety and infrastructure investment.