Puerto Rico turns to lottery to light up gray economy

(Reuters) - Instead of just fries, Veronica Rodriguez got a free automobile with her meal at a Burger King in Corozal, a mountain town in Puerto Rico.

For Betzaida Pacheco Rosado, a free car came after a visit to a Supercuts hair salon in the San Juan suburb of Bayamon.

Both won their cars with numbered shop receipts used in Puerto Rico's fledgling government lottery aimed at food-cart sales and other tiny cash transactions in the Caribbean island's untaxed $14 billion gray economy.

Urgently looking to boost revenue after six years of recession, government officials hope the island's sales-and-use tax lottery -- or IVU (impuesto sobre ventas y uso) Loto, as it is called in Spanish -- will jump-start collection of sales taxes, which came in below expectations in the fiscal year ended in June.

The IVU Loto automatically enters shoppers in twice weekly cash draws for as much as $25,000, as well as car raffles, and is just a single prong of a government campaign to get more revenue from Puerto Rico's 7 percent sales-and-use tax.

The campaign matters beyond Puerto Rico, a U.S. commonwealth with a 15 percent jobless rates, a dwindling population, and an outsized $68 billion of outstanding municipal bonds that have been hit by a flurry of ratings cuts.

Though often rated as barely investment grade, Puerto Rico bonds carry high, tax-free interest payments and are a favorite of American investors, who are increasingly voicing worries about the island economy's ability to generate revenue and re-pay debts.

The IVU Loto, which was rolled out in a significant way only over the past year, is slowly sinking into Puerto Rico's daily life. Its appeal is more akin to coupon clipping than the passions engendered by Puerto Rico's two existing lottery systems, whose drawings are local media events and occasionally offer purses worth millions.

"I save all my receipts and, like once a month, I check to see the winning numbers on the Internet and sometimes on television," said Ramona Camacho, a mother of two from Guanica.

With more than 200,000 machines at more than 70,000 venues, IVU Loto receipts are now routinely handed out by hot-dog and baked-potato vendors using handheld devices, as well as by fruit and vegetable trucks in rural barrios.

For most merchants, the IVU Loto implementation has been painless, even if mandatory. That's because point-of-sale bank debit card machines are widely used in Puerto Rico, and stores with them merely needed a software update.

Merchants without the devices got IVU Loto machines from Puerto Rico's Treasury Department, which last year spent $10 million implementing the IVU Loto.

STILL EASY

Yet it is still possible to skirt paying the IVU by buying things in cash. Reuters reporters have been offered tax-free purchases everywhere from surf shops to notary publics.

Sterner techniques used by Puerto Rico's tax men include dunning letters for past taxes to 30,000 small businesses, fines for vendors who refuse an IVU Loto terminal, and a hot line to turn in neighborhood grocers suspected of fraud.

Even with the crackdown and the IVU Loto, Wall Street still fears Puerto Rico's economy will not be strong enough to lift sales taxes.

Highly sensitive to Puerto Rico's Wall Street reputation, government finance officials in July publicly challenged a downgrade by Moody's Investors Service of $16 billion of bonds backed by sales-tax revenue. Moody's expects the island's sales-tax revenue to be softer than anticipated.

"Future growth prospects are marginal," Janney Capital Markets Managing Director Alan Schankel said in a new report advising even the boldest municipal bond investors to keep Puerto Rico debt under 10 percent of holdings.

"It is evident that compliance with IVU is not acceptable by any means," Puerto Rico Treasury Secretary Jesus Mendez said, adding that low collections could present "a significant opportunity to generate revenues."

Although government lotteries date to China's Han Dynasty, rarely have they been used to boost tax compliance, according to academics Thomas Giebe of Humboldt University at Berlin and Paul Schweinzer of Britain's University of York.

Taiwan has had since 1951 a receipt lottery, in which each of 11.5 billion receipts carries an eight-digit lottery number.

Puerto Rico's Treasury now collects just about half of the potential IVU revenue on the island, according to a report by the Puerto Rico CPA Association and other studies.

The government had expected $200 million extra to be collected from sales tax revenue in fiscal 2012, which ended June 30. Although IVU revenue rose 3.1 percent to $1.141 billion, it still missed forecast by $165 million.

But Mendez said benefits of the IVU Loto and other steps started kicking in late spring, when IVU revenue gains outpaced the annual average, growing 7.1 percent in April, 3.9 percent in May and 5.8 percent in June.

Based on the fiscal fourth-quarter results, Mendez forecast meeting IVU targets in fiscal 2013, which began July 1. For its fiscal 2013 budget, the government is banking on a $265 million increase in IVU revenue.

"We were basically operating an honor system," Mendez told bond investors in a conference call. "There is only upside here."

(Additional reporting by Reuters in San Juan; Writing by Michael Connor; Editing by Tiziana Barghini and Steve Orlofsky)