While the credit rating agencies and bond holders wait for details on how Puerto Rico would replace 4.5% of the island's sales tax with a new excise tax beginning July 1, commonwealth officials say the tax revenue change will help to strengthen Puerto Rico's economy.
Gov. Anibal Acevedo Vila's proposal to eliminate 4.5% of the island's 7% sales tax, a revenue stream that backs $2.6 billion of Puerto Rico Sales Tax Financing Corp. bonds sold in mid-July is a concern for investors and credit rating agencies.
While the bonds' debt service fund receives the first percentage point of sales tax revenue, the corporation currently benefits from its ability to tap into the 4.5% of sales tax receipts, if need be, before the central government can access those funds, even to pay general obligation debt. Whether the bonds will continue to have that added cushion beyond the 1% dedication remains to be seen as the governor has yet to file legislation on the proposal that could undergo alterations as it moves through the legislature.
Moody's Investors Service Friday said that it would not place the debt, which it rates A1, on credit watch at this time, but the agency is monitoring how the commonwealth proceeds with the governor's proposal, which he announced Wednesday evening in his state of the commonwealth speech. The following day, Standard & Poor's placed the credit on CreditWatch with negative implications and Fitch Ratings placed it on rating watch negative. Both agencies rate the sales tax bonds A-plus.
A change in the revenue stream is a concern, as Moody's believes the 7% sales tax, which began in November 2006, was a move to help strengthen the commonwealth's finances and bring more funds into the island's coffers. Puerto Rico ended fiscal 2007 with a $322 deficit. That number is unaudited but could grow by the end of fiscal 2008, which is June 30. Officials are working on having a structurally balanced budget by 2010.
"One thing that the sales tax did was bring in a lot of extra revenue into the commonwealth and into the general fund and moving toward balance. They had such a history of imbalance, this was providing it much-needed extra revenues that got them much closer to balance," said Moody's analyst Emily Raimes.
In addition, the implementation and performance of the sales tax was a factor in the revision in November of the commonwealth's GO outlook to stable from negative, according to the Moody's release.
Moody's and Standard & Poor's rate the island Baa3 and BBB-minus, respectively. Fitch does not rate the commonwealth.
When Puerto Rico implemented the sales tax, it ended the then 6.6% excise tax on businesses. Now officials believe a new and improved excise tax could offer the same amount of revenue stream as the current sales tax funds and also help spark the island's economy, said Jorge Irizarry, president of the Governmental Development Bank for Puerto Rico, the commonwealth's financial adviser.
"[The sales tax] is affecting consumers in a way that is creating a drag on consumption and therefore is causing our recession to linger longer than would normally be the case," Irizarry said.
The old 6.6% excise tax allowed for an exemption of 23 different product categories. The new excise tax would exempt only two types of products - perscription medicines and prepared foods -thereby broadening the taxbase and making enforcement of the tax much easier, according to Irizarry.
Still, investors are keeping tabs on Acevedo Vila's proposal.
"I think this is always a little bit bothersome to investors when officials propose tax changes that have the potential to reduce the revenue stream that's dedicated towards the bonds," said Paul Brennan, vice president and portfolio manager at Nuveen Investments Inc., which participated in the $2.6 billion deal. "They keep saying they're going to replace it, but when elected officials propose cutting revenue streams that back bonds, that's never very popular with bond holders." q
