Puerto Rico Gov. Alejandro García Padilla, looking to bolster the U.S. territory’s fiscal position after a series of ratings downgrades, proposed an an operating budget for the coming fiscal year with 8.3% more spending and a 16% increase in revenue.
A central component of García Padilla’s expectations of higher operating budget revenues is a 191% increase in sales tax revenues to $1.607 billion in fiscal 2014. In a speech Thursday night, he said he plans to eliminate exemptions, including reseller’s exemption certificates that allow purchasers to avoid taxes on goods they plan to sell, a program he says is subject to widespread fraud. The governor proposes to replace the certificates with tax credits. The budget would also restore and extend a 4% tax on the operations of multinational firms, resulting in the second biggest increase in tax revenues to the general fund, $317 million.
Since December all three major ratings agencies have lowered the commonwealth’s general obligation debt rating to just above a speculative rating. They have voiced concerns about recurring budget deficits. García Padilla has made clear he wants to maintain access to the credit markets by taking actions that address the ratings agencies’ concerns.
“It’s not a slam dunk, but overall, it’s not a bad budget.” said Richard Larkin, senior credit analyst at Herbert J. Sims & Co.
Aside from the new revenue from taxes, Larkin said it was good that about $253 million of the spending increases will go to shoring up the pension system, and that the budget anticipates a decline in debt refinancings to $500 million in fiscal 2014, from $750 million this fiscal year, and a $200 million reduction of outstanding debt.
On the negative side of the ledger, Larkin said, the new fiscal budget anticipates a $750 million operating deficit. Up to early or middle calendar 2012, rating agency analysts had hoped the deficit would be eliminated by fiscal 2014.
Larkin said he is still in favor of owning Puerto Rico debt.
The budget calls for $9.835 billion in operating expenditures and consolidated budget expenditures of $29.031 billion.
Consolidated budget income would include $1.522 billion in bonds and loans in the coming fiscal year, a 44% decline from the current fiscal year. Bond and loan income would constitute 5.2% of all consolidated revenue for fiscal year 2014, which starts July 1. Service on the commonwealth’s debt is expected to take up 13.6% of the consolidated budget and 6.7% of the general fund. By comparison, debt service payments take up 6% of Illinois’s fiscal 2013 consolidated budget.
Municipal Markets Advisors managing director Robert Donahue, like Larkin, had a mixed view.
“Puerto Rico’s proposed budget shows that Governor García Padilla is taking a bold, yet risky, approach toward stimulating the commonwealth’s ailing economy and resolving the commonwealth’s structural imbalance,” he said.
García Padilla is proposing that the island’s sales tax rate go to 6.5% from 7%. This would be achieved by reducing municipalities’s cut of sales taxes to 1% from 1.5%. The commonwealth’s general fund and COFINA (Puerto Rico Sales Financing Corporation) will continue to get 2.75% each, a source close to the governor said.
“The budget’s central initiative is a reduction in the sales and use tax rate, coupled with a broadening of the base and elimination of exemptions,” Donahue said. “We are not concerned about COFINA bonds at this point as these should be insulated from the rate reduction [but] we do have concerns. Specifically, various tax reform efforts in the past that have failed to meet expectation, deepening the commonwealth’s fiscal and economic woes.”
Donahue also expressed concern about the budget’s forecast for 191% increase in SUT revenues to the general fund, saying similar past forecasted increases have failed to materialize. “We are also concerned by a large 8.3% spending increase that might appear to be appeasing union members that were upset by the recent pensions reforms. Many of the governor’s actions recently have been favorable to bondholders – the pension reform, the airport privatization, water rate hike, and suspension of tax reform – but the spending increases greatly concern us.”
