Puerto Rico officials are working on addressing a $1 billion budget gap for fiscal 2009, with potential proceeds from a concession agreement on the island's lottery possibly helping to close the projected deficit.

Leasing out the management of the commonwealth's lottery system could bring in "several billions" of revenue for the island's coffers, with $500 million of that going towards balancing the fiscal 2009 budget, which begins July 1.

"The proposed concession is expected to generate up to $3 billion in lease-concession proceeds," according to a recent Standard & Poor's report on the 2009 fiscal plan.

Jorge Irizarry, president of the Government Development Bank for Puerto Rico, said the proposal would consist of a lease ranging from 30 to 50 years, with a longer lease generating more revenue for the island. He declined to place a price tag on the lottery system.

"We can't say the amount because there will be bids on it, but it's in the several billions of dollars, multiple billions," Irizarry said. "We don't want to give our number out."

Current plans include using $500 million of the potential concession proceeds to help fill an expected $1 billion shortfall in the proposed $9.48 billion fiscal 2009 budget. Officials would then place the remaining funds in a trust that would give the island's coffers yearly earnings that match what the government currently receives in annual lottery revenues. Puerto Rico raises $150 million, on average, each year from its lottery system.

"The difference would be deposited in a trust that would generate an annuity equal to the current revenue that is being derived from the lottery," Irizarry said.

The second strategy to fill next year's budget includes selling roughly $500 million of revenue bonds backed by delinquent tax receipts. Those unpaid taxes could reach up to $2.9 billion, according to Irizarry, a sizeable revenue stream that the Treasury Department anticipates tapping with the help of BearingPoint, a global management and technology consulting company hired to assist the administration with improved collection methods.

"Already they're using BearingPoint as the adviser on a special collection management project where the collection efforts would be stepped up and made more effective," Irizarry said.

Both the lottery concession agreement and the plan to leverage delinquent tax receipts must receive legislative approval before the administration could move forward. Gov. Anibal Acevedo Vila filed legislation for the initiatives along with the proposed fiscal 2009 budget, which he released on March 14.

In response to the governor's plan, Standard & Poor's announced on Monday that the commonwealth's BBB-minus rating is not immediately affected by the news of the projected $1 billion deficit for next year as analysts were expecting Puerto Rico's goal of reaching structural balance by 2010 to be very difficult for the island. Moody's Investors Service rates the island Baa3.

"In our downgrade of the commonwealth's general obligation rating to BBB-minus from BBB in May 2007, we cited the continuing difficulties with reducing the accrued deficit, and our expectation that the commonwealth's goal of a structurally balanced budget by fiscal 2010 would be difficult to achieve, " Standard & Poor's analysts Horacio Aldrete-Sanchez and David Hitchcock wrote. "We anticipated structural imbalance persisting."

The imbalance is due in part to rising costs for the government, including an additional $41 million to help cover expenses for the upcoming general elections in November, and another $70 million going towards municipalities, the University of Puerto Rico, and the judicial branch.

Meanwhile, officials anticipate that revenues will drop in fiscal 2009 by $183 million, according to Armando Valdes, director of the Office of Management and Budget. The commonwealth has been tackling a structural imbalance for the past few years, with that deficit reaching $1.41 billion in 2006, then dropping to $746 million and $556 million in fiscal 2007 and 2008, respectively, according to Standard & Poor's.

In looking at the $556 million budget gap for the current fiscal year, which ends June 30, officials anticipate using $287 million of federal reimbursements, $60 million of unpaid taxes, budget cuts, and potential debt refunding for savings to balance the budget, according to Standard & Poor's.

"The treasury secretary is initiating a very aggressive revenue management program that he expects will increase current fiscal year revenues by collecting back taxes from people who have not met their tax responsibility for the last few years," Valdes said. "And, we're also very aggressively dealing with federal reimbursements of funds."

Along with releasing the fiscal 2009 budget, Acevedo Vila advanced his initiative to decrease the island's sales tax to 2.5% from 7% beginning July 1, and replace the lost revenue from the reduction with a revamped 6.6% excise tax. The governor will file legislation for the change "shortly."

In June, the Puerto Rico Sales Tax Financing Corp. sold $2.6 billion of debt backed by the island's sales tax revenues, with a dedicated 1% of sales tax revenues supporting the credit's debt service fund. The corporation also has access to 4.5% of sales tax revenues to cover debt service costs, if the initial 1% is ever insufficient. The remaining 1.5% goes to local governments and municipalities.

While officials in Acevedo Vila's administration say the corporation will continue to receive the 1% sales tax revenue stream and have access to excise tax revenues to help cover debt service payments, bond holders have expressed concern about the revenue change since Acevedo Vila first announced his plan to decrease the sales tax during his state of the commonwealth speech on Feb. 6.

Jill Richman, director of long-term municipal research at Evergreen Investment Management Co., said Puerto Rico is a credit that the company watches very closely as the island deals with its structural imbalances and that the potential sales tax change "is a little disturbing." Richman mentioned that if officials implement the excise tax, the market will have to wait and see what impact that has on residents and on imports.

"For us, what does that say that they came in really quickly and changed this structure and there could be some larger implications here on the economy?" Richman said. "They've been very optimistic in the past and we obviously have to take what they say and really analyze if the potential outcome will be what they've said in the past."

Yet before the administration can change the sales tax, Acevedo Vila's proposal must pass through the legislature, a process that could prove to be very difficult as Senate President Kenneth McClintock opposes the excise tax and prefers the sales tax. In addition, while House Speaker Jose Aponte approves reducing the sales tax, he does not support implementing the excise tax and prefers budgetary cuts instead.

"If I were Wall Street, I would not worry at all about any changes to the sales tax, not at all," McClintock said. "There is no chance in hell that we would approve what essentially would be a tax increase because [the governor] would reduce the sales tax and replace it with the horrendous excise tax that we all campaigned against in the past and that's not going to happen."

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