Puerto Rico leader pushes for value-added tax amid scrutiny from public, credit rating agency

MarketsAssociated Press

Puerto Rico's governor on Friday defended his proposal to create a 16 percent value-added tax as pressure built on the government to fix its finances.

Gov. Alejandro Garcia Padilla held a round table discussion with other officials to stress that the tax is needed to help the U.S. territory emerge from an eight-year recession and pay off $73 billion in public debt.

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The meeting was held just hours after Standard & Poor's lowered its rating on Puerto Rico's general obligation bonds, warning that the government might not be able to honor its debt and fund public services.

Garcia dismissed those concerns and said that creating a value-added tax as part of a larger tax reform would generate an estimated $1.5 billion.

"This would guarantee the government's ability to pay its future expenses and previous debts with recurring funds," he said.

Standard & Poor's disagreed, saying the value-added tax could have negative consequences because the government has struggled to collect tax revenues in the past. It noted that the current 7 percent sales tax has not generated the anticipated revenues or reduced tax evasion.

"Puerto Rico's focus more recently has turned to new rounds of financing to simply maintain critical levels of operating cash, while paying a steep price for acquiring new financing. All of this poses a threat, in our view, to the commonwealth's ability to continue providing basic governmental services," the agency said.

The downgrade comes as Puerto Rico considers a $2 billion bond sale to raise more money. But it is unlikely investors will be swayed by the report, said David Tawil, co-founder and portfolio manager of New York-based Maglan Capital, which follows distressed companies.

"The hedge funds that are currently the largest investors and the municipal bond funds that have stuck with their investment in Puerto Rico are not at this point making their decisions on the basis of S&P... or Moody's or Fitch's for that matter," he said by phone.

All three agencies downgraded Puerto Rico's debt to junk last year.

Public hearings will begin soon on the proposed value-added tax, which would not apply to items including petroleum, prescription medication and certain foods.

The tax is part of legislation that also calls for income tax breaks, with income tax not applied to the first $40,000 earned by individuals or $80,000 for a couple. If approved, some 835,000 people would not pay any income tax.