STATEMENT OF DAVID B. COHEN DEPUTY ASSISTANT SECRETARY OF THE INTERIOR FOR INSULAR AFFAIRS BEFORE THE SENATE COMMITTEE ON ENERGY AND NATURAL RESOURCES REGARDING THE STATE OF THE ECONOMIES AND FISCAL AFFAIRS OF THE TERRITORIES OF AMERICAN SAMOA, THE COMMONWEALTH OF THE NORTHERN MARIANA ISLAND, GUAM AND THE UNITED STATES VIRGIN ISLANDS March 1, 2006 Mr. Chairman and members of the Committee, thank you for the opportunity to offer thoughts on the economies and fiscal affairs of American Samoa, the Commonwealth of the Northern Mariana Islands (CNMI), Guam, and the United States Virgin Islands. In summary, while there is room for optimism in the long run, three of the four territories are facing economic challenges, and all four are facing fiscal difficulties. We are not certain how these will unfold, but they require attention. Before discussing the specific case of each territory, I will highlight the challenges they face in common. Although the four territories are distinct from one another, they share important characteristics. Each has very limited land and resources. Each has a small population, and a limited pool of expertise to address the community’s critical needs. Each is located in an area that is highly prone to destructive typhoons, cyclones, or hurricanes. Each is relatively new to self-government. Because of remoteness and a lack of resources, each territory faces high transportation costs to import the basic necessities. Each territory is heavily reliant on air links to the outside world, but these links are often characterized by a lack of competition, high prices, and unreliable service. With the exception of Guam, each of the territories has the challenge of providing a full range of government services that cover multiple islands. These services must be provided with a very limited pool of trained and experienced personnel. There are low levels of immigration to the territories from which to supplement the pool of talent and resources. Each territory has a fairly limited private sector that is dominated by one or two major industries. Minimum wage rates are high in comparison to the low-wage regions of the world in which they are located. As a result of all of these factors combined, each of the territories has a standard of living that is lower than that of any state—in most cases significantly so. These challenges are exacerbated by the generally poor quality of critical infrastructure in the territories. Guam and the U.S. Virgin Islands are both subject to consent decrees that require improvements in their drinking water and wastewater systems. Saipan, the largest island in the CNMI and its civic, business, and government center, is the only community of its size in the United States that does not have 24-hour access to potable water. Each territory faces serious solid waste disposal issues. Guam is under a Federal consent decree to shut down its current landfill and build a replacement. Most of the power grids and generating systems in the territories are old, inefficient and vulnerable to the tropical cyclones that regularly occur in the Caribbean and the Pacific. The territories depend, almost entirely, on imported fossil fuels for their energy needs. Increases in the price of oil have added significantly to the financial burdens all the territories must endure. Fuel costs, in addition to problems with maintenance and financial management, have led to rolling blackouts on Saipan. American Samoa Of the four territories, American Samoa has the narrowest economic base and the most static economy. The territory’s private sector is anchored by two tuna canneries that have been in business in the territory for more than five decades. According to a December 8 2005 letter by Congressman Eni Faleomavaega the canneries account, directly or indirectly, for over 80 percent of the private sector economy of the territory. It is easy to illustrate the importance of the canneries to the economy of American Samoa. In 2004, according to the U.S. Department of Labor, the canneries directly employed 4,738 workers (38.6 percent of all surveyed workers in the territory), paid an average hourly wage rate of $3.60, and accounted for 24.5 percent of the territory’s total wage bill for all workers. The American Samoa Government (ASG), on the other hand, employed 5,124 persons (41.8 percent of all surveyed workers in American Samoa) at an average hourly wage rate of $7.99, and represented 58.9 percent of the territory’s total wage bill in 2004. The third largest employer in American Samoa, the trade and services sector, made up only 8.3 percent of the total wage bill while employing 10.3 percent of all surveyed workers. Not included in these statistics are workers who are exempted from coverage of the Federal Fair Labor Standards Act. Because of the territory’s reliance on the canneries, if they leave American Samoa precipitously, the economy of American Samoa would be devastated. The demise of the canning industry would leave American Samoa with no viable industry and no major employer other than the local government and the merchants that sell to it and its employees. At least in the short run, this would leave American Samoa almost wholly dependent on direct assistance from the Federal government. It would likely result in an increase in Federal assistance to the territory, as well as significant migration by U.S. national residents of the territory to Hawaii or other west coast states in search of work and benefits. In addition, without the high volume of tuna shipments from the territory, the cost of shipping essential goods into the territory would likely increase. This would cause prices to rise at a time when aggregate income in the territory would be falling, exacerbating the challenges even further. In the long run, it is likely that the advancement of free trade regimes under which foreign nations receive access to the U.S. market on terms comparable to what American Samoa currently enjoys will eventually cause the canneries to leave. In addition to its isolation from major trade routes, American Samoa is at a great competitive disadvantage in labor costs as compared to countries such as Thailand and the Philippines. The American Samoa canneries have reported that labor rates in 2001 for those two countries were 67 cents and 66 cents per hour, respectively. The canneries paid an average of $3.60 an hour in 2004. To counter the wage rate disadvantage, the canneries have relied on the possessions tax credit under section 936 of the Internal Revenue Code and on duty-free access to the U.S. market. The possessions tax credit for the canneries expired at the end of 2005, but a one year extension is provided in the House version of the Tax Reconciliation bill currently being considered in conference. On November 9, 2005, the Secretary of the Interior sent a letter to the Chairs of the House Committee on Ways and Means and Senate Finance Committee expressing the Administration’s support for a temporary extension of the possession tax credit to allow the American Samoa Government to develop a diversified private sector economy. American Samoa is really in a race against the clock before the trade advantages currently enjoyed by the American Samoa tuna canneries are expanded to other countries and regions. The territory urgently needs to wean its economy from excessive dependence on the canneries before they actually depart. As we face the prospects of a post-cannery American Samoa, it is noteworthy that the residents of the territory today have the lowest per capita gross domestic product (GDP) of any state or territory in the American political family. Preliminary estimates of the U.S. Census Bureau in 2005 (based on 2002 data) showed American Samoa’s GDP at $558.8 million, or $9,041 per capita. American Samoa’s per capita GDP is equal to only 34.4 percent of the lowest of the states and 22.8 percent of the national average. Fiscally, the ASG continues to face challenges, but is making progress. In response to the Department of the Interior’s concerns about financial management issues and the broader goal of advancing fiscal discipline in the territories, the Secretary of the Interior and the ASG entered into a Memorandum of Agreement in 2002 which requires a fiscal reform plan for bringing annual operating expenses in line with revenues. In 2005, the Office of Insular Affairs issued a high-risk grantee declaration for the ASG. The declaration, a statement of warning, was centered primarily on the independent auditors’ opinions of financial statements that identified severe and material weaknesses in internal controls over reporting and compliance with Federal grant program requirements. The conditions for lifting the high-risk designation include a requirement that the local government produce its annual single audits in a timely fashion with no material qualifications for at least two consecutive years. As of September 30, 2005, the ASG identified a cumulative unaudited surplus of $8.8 million, but a more recent report for fiscal year 2006 showed a first quarter shortfall of $4.86 million. As these numbers suggest, the fiscal health of the ASG remains unpredictable. Commonwealth of the Northern Mariana Islands The CNMI economy is besieged by changes in regional tourism markets and the advancement of free trade. During the last two decades, the garment industry has been one of the two pillars of the CNMI economy, along with tourism. The garment industry succeeded, and even surpassed tourism at its peak in the late 1990s, because of two trade provisions: (1) quotas on imports from low-cost producers of garments, and (2) duty-free export of goods manufactured in the CNMI to the United States. Also, the CNMI has benefited from its ability to control its immigration and establish its own minimum wage. With virtually no military installations and very limited military spending, the CNMI’s ability to import labor and set its own minimum wage has been essential to its economic survival. With its labor, immigration and export advantages, the CNMI established a successful garment manufacturing industry in the 1980s. At its peak in 1999-2000, the industry shipped well over $1 billion worth of garments to the United States and employed around 16,000 mostly foreign workers directly. It also paid roughly $79 million in taxes and fees into the CNMI treasury, about 35 percent of total public revenues at the time. In 2004, shipments to the United States were down to $807 million, followed by $677 million in 2005. Since the taxes and fees the garment-makers pay to the CNMI treasury are a fixed percent of sales, losses in sales volume show up directly in public revenues. Import quotas were lifted on January 1, 2005 under provisions of a new global trade regime for textiles and clothing under the agreement that established the World Trade Organization in 1994. Some quotas were re-imposed on China by President Bush on a temporary basis and then through a bilateral agreement with China, but these quotas will expire after 2008. In the mean time, in anticipation of the new trade regime, the garment industry had already begun consolidation and some relocation of operations, causing decline in both production and the payment of taxes and fees. It now looks increasingly likely that the garment industry in its current form will not survive in the long term. During slowdowns in tourism since the 1990s, arising from the Asian financial crisis, the effects of the terrorist attacks on the United States, SARS, and other factors, the garment industry kept the economy and government afloat. In fact, of all four territories, the CNMI has so far been the most self-sufficient in terms of local tax revenues. The decline of the garment industry could change that. Between April 2004 and February 2006, nine of the 27 garment factories on Saipan have closed, leaving 18 still operating. An estimated total of 3,842 jobs have been lost. What makes the CNMI’s challenges more compelling is that both of its major industries are declining at the same time. Just as the CNMI’s tourism industry was recovering from a period of stagnation and decline, it was dealt a serious blow in October 2005 when Japan Air Lines (JAL) discontinued its scheduled flights between Japan and Saipan. Since Japanese tourists make up about 73 percent of all tourists and JAL carried about 40 percent of all Japanese tourists to the CNMI, JAL’s decision cut about 29 percent of tourists to the islands. As a result, total arrivals in 2005 were down to 506,846. At its peak, just before the 1977-98 Asian financial crisis, the CNMI welcomed 736,117 tourists, according to the Mariana Visitors Authority. Still, the CNMI tourism market has made some progress since JAL’s pullout. For example, Northwest Airlines, which has had a daily flight between Tokyo and Saipan, will increase that frequency to 10 flights per week in April. Like American Samoa, the per capita GDP of the CNMI is lower than that of any state. In 2005, the U.S. Census Bureau’s preliminary estimate of the CNMI’s GDP was $1 billion. With a total population of 75,066, the CNMI’s per capita GDP was an estimated $13,350, a figure 50.9 percent of the lowest state per capita GDP, and 33.7 percent of the national per capita GDP. Fiscally, the CNMI is experiencing declining revenues and government cutbacks. For fiscal year 2006, the outgoing Governor proposed a total budget of $213 million. This figure was revised downward to $198.5 million by the current Governor, with the consent of the Legislature. CNMI economic challenges should be expected to result in continued fiscal challenges as well. Guam Like the CNMI, Guam relies heavily on two major industries. In Guam’s case they are tourism and national defense. From 2001 to 2003 several factors adversely affected Guam’s economy. These included the Asian financial crisis, the effects of the terrorist attacks on the United States on September 11, 2001, and those arising from regional economic and financial and public health concerns. In 2003, tourists to Guam numbered fewer than one million for the first time since 1993. Since then tourism has been on the rise. In addition, there have been unusually destructive typhoons in the last five years which have caused significant damage to the urban infrastructure as well as the natural environment. It may be years, perhaps decades, before some of this damage can be repaired. In contrast to the CNMI, present-day regional and global changes seem to be working in Guam’s favor. The overall economic outlook appears much brighter than at any time in recent years. Guam’s major business, tourism, is on the rebound, mainly because of the resurgent Japanese economy. Because nearly 80 percent of the tourists visiting Guam annually are from Japan, improvements in that country’s economic and financial fortunes have a direct effect on Guam. JAL’s decision to realign its service between Japan and the Mariana Islands has resulted in some flight cutbacks, but it did not halt scheduled service altogether, as it did to the CNMI. Also, other carriers, mainly American carriers, have picked up some of the routes JAL left behind. As recent figures show, Guam’s tourism appears poised for growth. In 2005 as a whole, Guam received 1.2 million tourists, up 5.8 percent from the year before. With the Japanese economy rebounding and a record 18 million Japanese planning to travel in 2006, according the Japan Travel Bureau, the likelihood is that Guam will benefit from some of this increase. Guam’s other major source of income, the military presence on Guam, is also on the rise. The Department of Defense recently unveiled plans that call for the transfer of up to 6,000 Marines and their dependents from Okinawa, Japan, to Guam over the next six years. This move would increase the number of military personnel on Guam to over 10,000 and raise Department of Defense spending levels on the island substantially. Base improvements, including those in anticipation of the Marines moving to Guam, have added fuel to local construction industry. It just may be that the military’s transfer of personnel and dependents to the island will take Guam back to its economic heyday. Although Guam has a stronger economic base than the either American Samoa or the CNMI, its per capita income continues to be lower than of any state. In 2005, the U.S. Census Bureau estimated that Guam’s GDP was roughly $3.7 billion and, with a total population of 162,326, had a per capita GDP of $22,661. That amount would be 86.3 percent of the lowest for a state, and 57.1 percent of the nation as a whole. Fiscally, Guam has struggled with continuing deficits for the last decade. In fiscal year 1996, GovGuam had a surplus of $19.6 million that helped pare down its cumulative deficit of $165.2 million that it carried over from the previous year. Despite recent efforts, from early retirement programs to closing down whole government agencies (the Department of Commerce) and other measures, the deficits have persisted. In the Governor’s Executive Budget for fiscal year 2006, the cumulative deficit reached $361.9 million. Some of this shortfall is the result of GovGuam meeting the needs of citizens after natural disasters, some of it is attributable to slower than anticipated growth in revenues, and some of it attributed to the inability of leaders in the relevant branches of government to reach consensus on the need to reduce the size of government. It is not clear how or when this large deficit will be eliminated, but the overall future of the economy looks better than any time in the last decade. United States Virgin Islands The economy of the U.S. Virgin Islands is relatively more diversified and has performed more favorably in recent years than the economies of the Pacific territories. However, the fiscal and economic health of the territory face a potentially serious short-term challenge, the magnitude of which is difficult to predict. In 2001, new territorial law added incentives for attracting new businesses to the islands. Service businesses, such as financial services providers, were sought to help diversify the economy. This incentive program is operated by the territory’s Economic Development Commission (EDC), and is commonly referred to as the EDC program. The enhanced provisions of 2001 attracted many businesses to the U.S. Virgin Islands, bringing large amounts of startup capital funds to build infrastructure and housing units. The Government of the Virgin Islands credits the EDC businesses with bringing approximately $100-120 million annually to the Virgin Islands treasury. This is a significant portion of its $600 million in total annual revenue. These figures do not include taxes paid by employees of these companies or by other businesses and employees that rely upon the economic activity generated by the EDC businesses. When Congress enacted the American Jobs Creation Act of 2004, however, it cast into doubt the future of the EDC program. The statute appeared to disqualify many EDC beneficiaries, especially those that had relocated to the Virgin Islands after the program was expanded in 2001, from receiving the benefits of the program. The U.S. Department of the Treasury and the Internal Revenue Service recently issued regulations to provide guidance on certain provisions of the statute. Regulations on other important provisions of the statute are still being prepared. Virgin Islands officials are concerned that a significant number of EDC beneficiaries may close their Virgin Islands operations as a result of the statute and regulations. The result of such closure would be a corresponding loss of tax revenues, jobs, construction activity, other economic activity, and charitable giving, the magnitude of which is difficult to estimate. Although the Virgin Islands has succeeded in attracting some high net worth individuals in recent years, the territory on average has a lower per capita income than in any of the states. In 2005, the U.S. Census Bureau estimated that the U.S. Virgin Islands had a GDP of $2.8 billion and a per capita GDP of $25,815 which would be 98.3 percent of the lowest of the states, and 65.1 percent of the nation as a whole. Role of the Public and Private Sectors It is clear that the territories will not be able to address the significant challenges they face unless they significantly strengthen their economies. This cannot occur unless the private sector in each of the territories is strengthened sufficiently to wean the economy from unsustainable reliance on the public sector. That is why the Secretary of the Interior has stated that her top priority for the territories is to promote private sector economic development. Under the Secretary’s leadership, the Department of the Interior has been implementing a comprehensive program to advance this priority. Despite the many challenges they face, the territories still have competitive advantages in certain areas. The adaptable companies can prosper in the territories. The Office of Insular Affairs has devoted significant effort to finding those companies and to facilitating interaction between these companies and the territories’ relevant private sector and government representatives. We have conducted extensive research through our Island Fellows Program, in which M.B.A. students from prestigious institutions such as Wharton and Harvard have identified industries and companies that fit well with the unique needs and competitive advantages of the territories. The Secretary has hosted two conferences at which these companies have met with potential local business partners and government officials from the territories. A third conference is scheduled for November. We have also organized Business Opportunities Missions, taking business people to the territories to conduct on-site due diligence. Our first Business Opportunities Mission, to Guam, Saipan and Palau, was led by Deputy Secretary Lynn Scarlett in May 2005. During the period of March 5-10, Deputy Secretary Scarlett will lead General Electric, Microsoft, Marriott, and other top companies on a Business Opportunities Mission to the Virgin Islands. A Business Opportunities Mission to American Samoa is planned for May. As a result of our facilitation efforts, a number of business opportunities in the territories have either been consummated or are being actively pursued. The most important result of our program, however, is the realization by territorial leaders that there is no alternative to this type of effort to strengthen the private sector, and that they need to be leading it themselves. Because of the special fiscal and economic challenges faced by the territories, several successive administrations, like this Administration, have supported tax and trade provisions that help the territories generate sufficient economic activity and tax revenue to meet the most basic needs of their people. Notwithstanding these incentives, each of the territories continues to experience economic and fiscal difficulties. Longstanding special tax provisions for the territories manifest an important underlying principle of Federal territorial policy; namely, the Federal Government does not treat the territories as sources of revenue. The Federal government has a strong interest in maintaining and enhancing the economic and fiscal well-being of the territories. A fiscal and economic crisis in any of the territories would weaken the effect of investments that United States taxpayers have already made in the areas of housing, education, health, social welfare, fiscal management and other areas. For example, the U.S. taxpayer has already made sizeable investments in the territories to ensure that housing needs for the poor are addressed, that schools have the resources to retain accreditation, that minimum health and environmental standards are met, that critical infrastructure is constructed and that basic standards of social welfare are satisfied. Active Federal agencies have been the Departments of the Interior, Housing and Urban Development, Education, Health and Human Services, Agriculture, Transportation and Homeland Security, and the Environmental Protection Agency. It should be noted that three of the territories are on the United Nations Committee on Decolonization’s list of only 16 non-self-governing entities in the world. Although the United States rightly rejects this characterization, America’s critics would not hesitate to use any deterioration in living standards in the territories to buttress their attempts to de-legitimize United States sovereignty in the territories. Mr. Chairman, there are many good reasons for the average American to care about the well-being of the territories. Let me add one more: The tremendous sacrifice that men and women from the territories have made to keep our country free. Mr. Chairman, I made the sad calculation a couple of months ago that a resident of American Samoa was over 15 times more likely to have been killed in action in Iraq than a resident of the nation as a whole. This, our smallest territory, has lost seven men and women in the conflict, approximately one for every 9,000 people who live in the territory. The Governor’s own daughter recently returned from a one-year tour of duty in Iraq. Throughout the islands, families are making tremendous sacrifices to defend freedom. The U.S. Virgin Islands has lost four servicemen in Iraq. Guam has lost four. The Northern Mariana Islands has lost three soldiers, and I attended the funeral for each one. Mr. Chairman, this Administration is committed to working with you to ensure that the Federal policy towards the territories contributes positively to communities that have contributed so much to our nation.