Puerto Rico’s solvency may hang on a potentially unconstitutional corporate tax

Last June, I asked if the U.S. Treasury was bailing out Puerto Rico with an unusual interpretation of the federal tax code. This waiver or exemption allowed U.S. multinationals operating in Puerto Rico to credit taxes that were paid to Puerto Rico on their federal tax bill. The tax, referred to as Act 154, was passed by the Puerto Rico legislature in 2011. It brought in approximately $1.6 billion in 2011.

When preparing its 2014 budget, Puerto Rico had a massive $1.5 billion deficit to fill. The governor had proposed expanding the “sales and use tax” (SUT or Cofina) by 73 percent, but this was met with strong resistance from the business community. The corporate excise tax (Act 154) was raised and part of the budget deficit was filled (an $800 million deficit is still projected for the current fiscal year).

Last week an excellent explanation of the corporate excise tax was published by Martin Sullivan on The Tax Analysts Blog. Sullivan highlighted the tax’s importance at 20 percent of general fund revenues:

On February 28, 2013, the government of Puerto Rico, citing the need for additional tax revenue because of continued poor economic conditions, expanded and extended the life of the excise tax to 2017 (Act 2-2013). Under the revised law, the tax rate will be 4 percent beginning on July 1, 2013, and through its new expiration date of December 31, 2017. The tax is now expected to raise $1.96 billion in fiscal 2014 (which began in July 2013). As shown in Figure 1, that is more than 20 percent of expected general fund revenue.

Sullivan questioned the validity of the tax and noted that the IRS had not ruled on whether it conformed to the U.S. tax code. Sullivan surveyed five tax attorneys who all had serious doubts about its constitutionality:

Muniland’s marijuana math

Source: ABC 7 News Denver

The sale of marijuana for recreational use was made legal in Colorado starting January 1, and it appears to be a big success. Product and tax revenue numbers are not yet available, but some have predicted that Colorado will bring in an estimated $40 million in tax revenue this year from marijuana sales. USA Today reported anticipated tax revenues of $1.9 billion in five years for Washington State, which legalized recreational use in November:

For consumers, the effective tax rate is 44 percent, according to the Washington Liquor Control Board. The sticker price includes a 25 percent tax on producers and a 25 percent tax on processors plus 25 percent added to the price of the product. Buyers also pay an additional 6.5 percent state sales tax.

The revenue could bring in as much as $1.9 billion in the first five years to go toward a variety of services, including social and health programs, a marijuana use hotline and the Alcohol and Drug Abuse Institute at the University of Washington. The state’s Liquor Control Board will begin issuing permits for marijuana retail locations starting Nov. 18. Under the law, the state can have a maximum of 334 retail locations.

Chicago firemen pensions is a 90 year-old problem


Chicago is drowning in unfunded pension liabilities. Last month, Illinois passed pension reform for state pensions, but did not take up Chicago’s pensions. Illinois governor Pat Quinn says the city’s pension will be taken up in the spring. Chicago’s pensions are deeply underfunded and have unique problems. The Chicago Tribune wrote:

The much-discussed government worker pension debt in Chicago now has a price tag: $18,596 for every man, woman and child living in the city.

That per-person figure is the highest among the nation’s 25 largest cities. It’s nearly double that of New York, the city with the second-largest tab. And it’s more than five times the median for locales included in the new study done by a major investment research company.

The Brent Spence Bridge financing puzzle

The claim is often made that there are substantial savings for taxpayers when a public private partnership (P3) is used to build infrastructure. This claim is rarely backed with economic analysis. In fact, after a project like the Chicago parking meter deal is in place, it is often discovered that the project is bad economics for taxpayers.

P3s are not all one-size-fits-all. Public advocacy group “In the Public Interest” breaks them down into these categories:

Long-Term Lease Agreement - This is an agreement where a private company (or consortium of companies) receives the right to collect revenues associated with an existing asset in exchange for an upfront fee to the governmental entity. Examples of this model include the long-term leases of the Chicago parking meters [or the near bankrupt Indiana Toll Road].

An index maker’s view of muniland

J.R. Rieger, Vice President of Fixed Income Indices at S&P Dow Jones Indices, hosted a webinar about the data he uses to understand muniland and the performance of munis versus corporate bonds. Here is some of his team’s analysis.

State and local tax collection data from the U.S. Census is widely used in muniland:

Below is a comparison between muniland and corporate bond defaults in 2013 (S&P Ratings data – a separate operating unit within McGraw Hill). Note the 0.107 percent default rate for investment-grade municipal bonds, 0.807 percent default rate for municipal high-yield bonds versus 2.10 percent in the S&P corporate speculative grade (high yield) index.

Negative signals from Puerto Rico

The condition of Puerto Rico’s economy is a key concern for bond investors and rating agencies. Although its tax revenues have risen sharply as the government has increased various taxes, the economy has been contracting. From a recent Morningstar report:

The contracting economy remains a core concern for us, as Puerto Rico has now experienced 12 consecutive months of economic contraction relative to last year, and the monthly decline in economic activity in the first half of fiscal 2014 has been the most rapid since fiscal 2010.

Puerto Rico measures its economy using the PR Economic Activity Index. The EAI is made up of four components: payroll employment, cement sales, gasoline consumption and electricity generation. Although most December economic figures have not been publicly released, Standard & Poor’s ominously placed Puerto Rico general obligation and appropriation debt on “CreditWatch with negative implications” on January 24th. S&P rates Puerto Rico BBB-, its lowest investment-grade rating:

The Senate’s latest twist: The American Infrastructure Fund

A bipartisan group of eleven U.S. Senators, led by Colorado Democrat Michael Bennet, has filed legislation to create the American Infrastructure Fund. Senate bill 1957 would:

Provide bond guarantees and make loans to states, local governments, and   infrastructure providers for investments in certain infrastructure projects, and provide equity investments in such projects, and for other purposes.

The trade industry association Sifma describes the legislation:

On January 17, a group of 11 U.S. Senators joined 50 House members to support a proposed national infrastructure bank funded with $50 billion of taxable bonds with a one percent interest rate. The Partnership to Build America Act (S. 1957), in line with the H.R. 2084, filed in the House in May by Rep. John Delaney, D-Md., aims to help state and local governments finance initiatives to build or repair roads, bridges, highways, ports, schools, and other infrastructure projects.

Will Puerto Rico sell general obligation bonds?

The New York Times reported that Morgan Stanley is shopping a potential $2 billion general obligation bond deal for Puerto Rico. Bloomberg followed up with a story that had a few more details about the offering that Puerto Rico supposedly has not authorized. According to Bloomberg the possible deal terms are:

The taxable general-obligation deal said to be under discussion would have maturities of at least five to seven years. The funds [hedge funds and distressed debt buyers] would assist the commonwealth as it struggles to turn around its shrinking economy. The discussions have cited possible yields of about 10 percent, the people said.

Let’s break this proposed issue into several pieces:

Taxable: Issuing taxable municipal bonds makes sense because it attracts a broader base of investors (including hedge funds, commercial banks and some insurance firms) outside of muniland that don’t take advantage of the municipal bond tax exemption. But the extremely high interest rate is a signal to any bond investor that the security has very high risk, regardless of its investment-grade rating from the three major raters. So we can rule out banks and insurance companies as buyers.

College football realignment spurs stadium upgrades

College football stadiums are undergoing upgrades and renovations. Wells Fargo senior analyst Randy Gerardes writes that this is a response to recent conference realignments and increased media revenues:

[C]olleges and universities have been undergoing significant athletic conference realignment to increase visibility and capture additional revenue from lucrative media contracts for the major football conferences. As universities enter new conferences, competition for top recruits stiffens, inspiring additional investment in athletic facilities, particularly for football.

Gerardes says that the investment is hoped to improve the fan experience, increase university brand recognition, meet rising student demand and spur financial support from alumni and donors.

The Port Authority’s big debt sinkhole

Bloomberg has a story about The Port Authority of New York and New Jersey bringing a $1 billion taxable bond offering to market without citing the George Washington Bridge closure problem in the risk section. I think whatever involvement New Jersey Governor Chris Christie or his staff had in closing the bridge has no bearing on the ability of the Port Authority to repay these new bonds. Governors come and go, but this momentous pile of debt remains outstanding.

Slate’s Matthew Yglesias piled onto Christie’s Port Authority caper with a piece about dismantling the Port Authority into smaller pieces and pushing it back to the states. Yglesias wrote (emphasis mine):

    Put the bridges and tunnels under the control of MTA Bridges and Tunnels, which runs the city’s other bridges and tunnels, and in exchange give New Jersey Transit a fixed share of toll revenue from the Hudson River crossings. Put the PATH train under the control of New Jersey Transit, which runs other commuter trains into Manhattan. Let the various airports all go their separate ways. They don’t need to be managed by a single entity. Give AirTrain JFK to the NYC Subway. Sell the random real-estate holdings [think World Trade Center].

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