In an effort to get more merchants to collect and pay sales taxes to the government, Puerto Rico plans to turn sales receipts there into lottery tickets.
The idea is to ramp-up sales-tax collections, an important revenue stream that backs a big chunk of the U.S. territory’s sizeable debt load. Analysts said increased compliance would be a credit positive for the sales-tax bonds and a revenue enhancer for the government.
By implementing a lottery system, officials aim to increase the number of merchants that charge the 7% tax and submit those revenues to the commonwealth’s Treasury Department, as customers will demand a receipt in order to participate.
The initiative, called IVU-LOTO, will begin island-wide on Jan. 20.
The Treasury Department is currently in the midst of a pilot IVU-LOTO program in Ponce, Puerto Rico’s second-largest city, located in the southern part of the island.
Puerto Rico captures only about 52% of the island’s sales tax, according to Pablo Hymovitz, assistant secretary for the internal revenue area in the Treasury Department. The government is looking to boost that collection rate to 74%, he said.
Officials anticipate the new lottery will add $75 million to $100 million of new revenue this year, with improved collections generating an estimated $400 million of additional revenue in fiscal 2012, according to Hymovitz .
“This is an enforcement effort that happens to have a lottery as a means to get taxpayers to require or to demand having a sales receipt,” he said.
Improving the island’s sales-tax collection rate could strengthen its sales-tax credit. The Puerto Rico Sales Tax Financing Corp., known by its Spanish acronym COFINA, has $13.4 billion of outstanding senior and subordinate sales-tax bonds.
Additional sales-tax receipts would also help the commonwealth balance its general fund budgets. Puerto Rico has been operating with a structural deficit for several years.
Under Gov. Luis Fortuño, the Treasury Department has been cracking down on tax evasion and strengthening all of its revenue streams.
“I think that definitely the debt of the commonwealth should continue to trade a little bit better because of all this effort,” said Tom Spalding, senior investment officer at Nuveen Investments. “I can’t speak specifically to this one program, but for investors who use Puerto Rico, it’s definitely a good thing.”
With IVU-LOTO, customers get a free lottery number on the bottom of sales receipts they receive from merchants when shopping or paying for services that include the 7% sales tax.
Officials anticipate the chance to win cash prizes in weekly drawings will prompt customers to ask for a sales receipt from merchants or persuade residents to patronize businesses that participate in IVU-LOTO.
That creates a paper trail between merchants and the Treasury Department. Evertec Inc. and Softex are the two software technology firms implementing the program. The companies will update businesses’ credit-card systems to include the lottery and also provide cash-only merchants with the proper IVU-LOTO technology. Officials are eyeing businesses that currently do not impose the 7% sales tax or fail to remit it to the Treasury.
Once in place, businesses must use the IVU-LOTO or pay fines.
“The main objective is that we’re trying to cover as many types of businesses so that the consumer can go to the merchant and demand that sales-tax receipt and the sales amount,” Hymovitz said. “Then in the Treasury Department, I’m going to take that information and I’m going to compare it against a merchant’s monthly returns.”
Puerto Rico’s sales-tax credit, with its double-A ratings on its senior bonds, is the commonwealth’s strongest financing tool. Moody’s Investors Service and Standard & Poor’s rate Puerto Rico’s general obligation credit A3 with a negative outlook and BBB-minus with a positive outlook, respectively.
The sales tax began in Puerto Rico in November 2006. During the past few years, the government has leveraged the revenue stream to help balance its budgets and pay down debt it owes to the Government Development Bank for Puerto Rico, the commonwealth’s financial agent.
Puerto Rico collected more than $1.1 billion of sales-tax revenue in 2007 and again in 2008, according to the GDB. Sales-tax performance dropped in 2009 to $970 million, due in large part to the recession.
The government has collected $918 million of sales-tax receipts from January through October of this year.
“Clearly the COFINA revenues have become a very important funding source and the more they can do to instill compliance behavior the better the outcome,” said John Hallacy, head of municipal research at Bank of America Merrill Lynch. “So clearly it’s focused on compliance and that is a positive.”
Hymovitz acknowledged that there may be technical glitches with the lottery system and that rogue merchants may still try to conduct business without using IVU-LOTO.
Still, he believes the program will boost collection rates overall.
Sergio Marxuach, policy director at the Center for the New Economy, doubts the government will gain the $400 million of additional revenue in fiscal 2012. CNE is a nonpartisan think tank in San Juan,
“I am a little bit skeptical of technological silver bullets to solve compliance problems,” Marxuach said in an e-mail. “And while the IVU-LOTO may yield a marginal increase in sales tax revenues, I am not sure the government will get the $400 million they are forecasting.”
Moody’s considers the low collection rate as a credit challenge for the COFINA bonds. It noted in a June 16 report that a “dramatic” growth in sales-tax revenues, leading to a significant increase in coverage could prompt a credit upgrade.
Combined estimated debt-service coverage on the COFINA senior and subordinate bonds, assuming a 4% growth rate, ranges from a low of 2.03 times in 2012 to 5.78 times in 2057, according to the official statement for the $1.6 billion Series 2010C subordinate bonds, which priced on June 23.
Using a growth rate of 1.57%, combined debt-service coverage ranges from 2.4 times in 2010 to 1.9 times in 2057, and drops to a minimum 1 times coverage in 2040 and 2041.
Puerto Rico’s sales tax is fairly broad-based and applies to the service industry, such as hairdressers and dry cleaners, as well as the retail industry.
The government does not impose the tax on automobiles and energy consumption, which Moody’s and Standard & Poor’s consider more volatile industries. Both rating agencies consider Puerto Rico’s sales tax performance to be stable.
Of the 7% tax, the COFINA bonds receive either 2.75% or a base amount, whichever is larger. The base amount is $550 million in 2010 and increases annually by 4% until 2041, when that cap reaches $1.85 billion. Sales-tax receipts flow into Puerto Rico’s general fund once the COFINA bonds receive the base amount. Municipalities get 1.5% of the 7% sales tax.
For the Series 2010C subordinate bonds, a term bond maturing in 2041 was trading last week in the 5.5% range.
