Puerto Rico eyes tax hikes to help cure deficit-officials

Wed Mar 27, 2013 3:19pm EDT

* Tax changes could bring in more than $1 billion

* Puerto Rico yields shoot up

* New governor's budget may debut in early April

March 27 (Reuters) - Puerto Rico's new government is eyeing more than $1 billion in tax hikes and other changes meant to fix chronic budget gaps worrying U.S. bond buyers and Wall Street credit rating agencies.

In the past two weeks, pointing to a widening current-year budget deficit for the Caribbean island's government, analysts at Standard & Poor's and Fitch Ratings knocked Puerto Rico's bond ratings to just above junk-bond level.

As credit ratings fell, Puerto Rico's yields, which were already the highest of any major borrower in the $3.7 trillion U.S. municipal market, went up amid concerns that institutional investors would unload the widely held debt, if Puerto Rico's ratings drop below investment grade.

Officials hope to raise $550 million by eliminating deductions and expanding the base of the commonwealth's sales & use tax, according to a Government Development Bank (GDB)presentation given to the investors.

Much of this increase would be made through the elimination of a reseller's exemption certificate, which allows business people to skip taxes on items used in products they sell. To combat the widespread abuse with the system, the government is proposing replacing the certificates with tax credits.

An additional $490 million would be raised through new taxes and revenue measures, according to the GDB.

The tax increases and other proposals now being considered are subject to change ahead of Gov. Alejandro Garcia Padilla's budget proposal, Office of Management & Budget Executive Director Carlos Rivas Quinones said.

Some tax hikes that were put in place by Padilla's predecessor, which had cut budget deficits and shrunk the size of the government workforce, would be scrapped, officials said.

The budget roll-out may come as early as next week.

The officials were looking to raise $172 million in additional corporate taxes, including $65 million through changes to the alternate minimum tax and $50 million from a new gross sales tax on merchants selling over $50 million annually.

Another proposal would raise $150 million through a 4 percent tax on some self-employed professionals, while freezing tax credits with questionable impact on economic growth would raise $78 million. A possible increase in an excise tax on cigarettes would be expected to raise $50 million.

The finance officials also said they may make changes in the island's lottery, such as joining the multi-state Powerball game, that would raise an estimated $40 million for the government.

SPREADS WIDEN

Since the ratings agencies lowered their rating on Puerto Rico's debt, general obligation spreads to top-rated bonds have grown in the past week by 25 basis points for 10-year and 20-year issues and 45 basis points for 30-year maturities, according to Municipal Market Data.

On Friday, when S&P's index of Puerto Rico debt lost a remarkable 1.4 percent, top government finance officials told investors in a private meeting they wanted revenue to total $9.7 billion during fiscal year 2014, which begins July 1.

Despite a jobless rate of 14.6 percent and population losses, Puerto Rico finances may be bottoming, according to John Mousseau, portfolio manager at Cumberland Advisors Inc.

"The underlying economics are improving," Mousseau said. "Tourism is doing well. All those new resorts and the planes are full. But the government has to right itself."

Since January, Padilla's government has extended and raised a commonwealth tax on the sales of multinationals operating in Puerto Rico to offshore affiliates.

GDB President Javier Ferrer, GDB Board Chairman David Chaffey and Treasury Secretary Melba Acosta also told investors the administration since January had approved a water rate hike, signed off on a public private partnership at the island's main international airport.

Last month, the government unveiled a proposed overhaul of its woefully under funded public pension system. An agreement between the government and legislative leaders calls for the plan, which hikes retirement ages and employee contributions to be approved next week.

Puerto Rico's current-year deficit is coming in well above initial forecasts of $1.1 billion and budget-gap narrowing steps being taken by the government will still leave an estimated $490 million shortfall, according to the Fitch analysts.

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