With an eye towards retaining Puerto Rico's investment-grade rating, Gov. Luis Fortuño late Tuesday announced a proposal to cut 30,000 government jobs and temporarily raise business and individual income taxes by 5% in order to close a $3.4 billion deficit.

The plan does not include an increase to the island's 7% sales tax or to its gas tax.

The commonwealth carries BBB-minus and Baa3 ratings from Standard & Poor's and Moody's Investors Service, respectively, both with stable outlooks. The investment community has expressed doubts about Puerto Rico's credit rating in light of the $3.4 billion deficit in the $9.48 billion fiscal 2009 budget and a prolonged recession, among other issues.

In addition, nearly $7 billion of Puerto Rico Highways and Transportation Authority debt now carry BBB ratings from Standard & Poor's after it downgraded the bonds last wek.

Standard & Poor's last week also dropped to BBB-minus from A-minus $58.5 million of Puerto Rico Port Authority debt issued for the international airport in San Juan.

The governor, a member of the New Progressive Party, said reducing the size of Puerto Rico's government and raising revenue are necessary in order for the island to keep its triple-B ratings.

"The time has come," Fortuño said in a televised speech. "We must act now, without hesitation, to save the little credibility we have in the bond market, and save our house."

Without an investment-grade rating on its general obligation debt, Puerto Rico will lose access to the municipal bond market and investors will be forced to place commonwealth GOs in high-yield funds, which are much smaller than the municipal-asset funds that investors typically use to hold Puerto Rico debt.

"If we fail to act, the negative impact on the island's economy would be massive, and recovery would take eight to 10 years, like it did in New York when that city lost its credit in the 1970s, and as it will surely happen to Detroit, which lost its credit last month," the governor said.

Fortuño's proposals will need approval from the legislature, which is controlled by the NPP. Plans include reducing the government's payroll of 300,000 employees by 30,000 through retirement incentives and layoffs, an initiative that would save $2 billion per year. The island's unemployment rate is already at 13%, with the government serving as the island's biggest employer. The administration would also suspend raises for two years for government employees.

Fortuño said he will cut his salary by 10% and lower salaries of agency heads by 5%.

In addition, the commonwealth would impose a moratorium on most tax credits to businesses, excluding the tourism, film, and manufacturing industries. Corporations would also see a temporary 5% tax hike on their earnings in the next two years, and the personal income tax for individuals making $100,000 or more, or $150,000 for couples, would also increase by 5% during that time frame.

Permanent tax-increase proposals include tax hikes on cigarettes and wine and beer.

In response to Fortuño's announcements, the opposition Popular Democratic Party yesterday filed legislation to enter the island's lottery system into a long-term lease, implement taxes on certain businesses, and restructure the government via department consolidations.

According to Rep. Hector Ferrer, the PDP's president, the measures would generate nearly $4 billion and avoid the 30,000 government employee layoffs.

Ferrer said the lottery concession proposal could bring in up to $3 billion, and that a 2% tax on foreign corporations and another 2% tax on insurance companies would generate $700 million and $200 million, respectively, per year.

"Firing 30,000 employees will be bad for the economy because that will take out of the economy 30,000 people that are paying mortgages, paying auto loans, paying personal loans, paying schools, and consuming," Ferrer said. "So that has a negative effect on the economy."

Standard & Poor's analyst Horacio Aldrete said that it is too early to indicate how the governor's proposals may affect the commonwealth's fiscal stability as the measures need to gain legislative approval, although the plan to reduce government expenditures is a step in the right direction.

"It's pretty premature to say what the impact of that would be until the legislature actually takes action on those proposals," Aldrete said. "I would say that the proposals do follow what the governor had outlined in terms of bringing the budget back into balance in three to five years and reducing government expenditures. But we'll wait to see what the legislature actually approves before we offer an opinion on the plan. But it addresses the issues that we believe would help the commonwealth bring its finances into balance."

To help counterbalance the administration's sizeable layoffs and 5% tax increases, the local economy will benefit from $5 billion of federal stimulus funds from the American Recovery and Reinvestment Act of 2009, which President Obama signed into law last month, and another $500 million local stimulus package.

Those funds will help support loans to more than 7,600 small and medium-sized businesses, finance capital projects at the municipal level, and fund job retraining and relocation programs, among other initiatives.

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