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Puerto Rico’s Fortuno Uses Game of Chance to Repair Tax System

A 10-digit lottery number on a crumpled Church’s Chicken receipt is Governor Luis Fortuno’s solution for pulling Puerto Rico from its “lost decade” and may salvage his popularity.

The number, printed at a Ponce restaurant by a machine that reports sales directly to the Commonwealth’s Treasury, seeks to turn every Puerto Rican into an enforcement agent. The program will give anyone with a receipt a chance to win $1,000 or a car, while forcing businesses to report and pay taxes.

Consumers have a “personal interest in making sure that the tax is collected and sent over to our local Treasury Department,” Fortuno, a 50-year-old Republican, said in an interview in his San Juan office.

Governors across the U.S. are confronting deficits that total $125 billion in the next fiscal year by cutting spending and raising money. Illinois increased its taxes and is borrowing $3.7 billion for its pension. Texas may cut 10 percent from its biennial budget. Fortuno’s approach is to crack down on cheating. His anti-tax-evasion policies will increase the commonwealth’s projected $8.1 billion revenue by $305 million this year, Treasury Secretary Luis Puig said in a telephone interview.

Pervasive Evasion

Photographer: Gabriel Gonzalez/Bloomberg

Luis Fortuno, governor of the U.S. territory of Puerto Rico. Close

Luis Fortuno, governor of the U.S. territory of Puerto Rico.

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Photographer: Gabriel Gonzalez/Bloomberg

Luis Fortuno, governor of the U.S. territory of Puerto Rico.

Free lottery tickets may be more to the public’s liking than other measures Fortuno took in his first two years in office. He sparked student strikes when he raised fees to help balance the university’s budget. He prompted street protests when he fired workers to help bring the territory’s deficit to $1 billion in the current fiscal year from 2009’s $3.3 billion, the largest of any state’s proportionate to revenue.

Now, still dealing with a contracting economy, Fortuno’s tax overhaul may prove more popular. He promoted a measure last year to boost revenue by tightening the net on collections, and another to cut taxes, which the Legislature passed Jan 31.

Only 52 percent of sales taxes are collected, according to a Treasury document. An underground economy has flourished, said Jose Villamil, chairman of Estudios Tecnicos, an economic consulting firm in San Juan, who estimated that the informal sector is 27 percent the size of the overall economy, which was $62.8 billion in 2009.

“The tax system is so oppressive that people basically want to avoid it,” he said in a telephone interview. “Tax evasion is pervasive; it includes high-income professions such as doctors and lawyers that collect fees in cash,” as well as people selling food and other items on the street.

Fixing the System

Fortuno’s measures include requiring banks to provide income information on some borrowers, limits on a mortgage- interest deduction and penalties for corporate tax evasion. The moves, along with a temporary 4 percent excise tax on foreign manufacturers, will allow the territory to lower business levies an average of 30 percent and individual assessments by 50 percent over six years. Residents who earn less than $20,000 no longer have to pay income taxes.

“There’s a general feeling in the people of Puerto Rico that the tax system is broken,” Xenia Velez Silva, executive director of the governor’s tax-reform committee, said in a telephone interview from San Juan.

Taking Profit

The former Spanish colony was ceded to the U.S. in 1898 after the Spanish-American War. The Caribbean sugar producer gained self-governing Commonwealth status in 1952, and a 1976 law that allowed U.S. companies to take home profits without income taxes prompted the opening of plants, including pharmaceutical manufacturers such as Eli Lilly & Co. and Novartis AG.

Its biggest public companies include the San Juan financial institution Popular Inc., which has a market capitalization of $3.4 billion, and insurance company Triple-S Management Corp., worth about $539 million.

Puerto Rico had trouble attracting businesses to a jurisdiction with complicated permitting laws and strict labor rules, said Villamil. That led to what economists and top officials call a “lost decade.”

Private payrolls fell 10 percent from January 2001 to January 2010, according to the U.S. Bureau of Labor Statistics. Workers flocked to the public sector, which provides three out of 10 jobs, or to the mainland, where the unemployment rate averaged 6 percentage points below that of the territory. Only Puerto Rico and Michigan lost population during the past 10 years, according to the U.S. Census.

‘Courageous Things’

Puerto Rico’s Chamber of Commerce, which represents more than 50 percent of private-sector employment, endorsed the tax overhaul, president Raul Gaya said in a telephone interview from San Juan.

“Fortuno has done some very courageous things,” he said. “Unfortunately, the economy has not been responding as we wish it would.”

In December, 20 months after the U.S. came out of recession, the territory’s economic activity index fell 2.5 percent. Growth will likely resume by March, Fortuno said.

To encourage that, he created a permits office to simplify the process and promoted scrapping the need for the Legislature to approve public-private partnerships.

The San Juan native with two U.S. university degrees developed the “aversion to government intervention” as a corporate lawyer.

“I got to understand much better from much closer how and why business decisions were taken and how government decisions affect those businesses,” he said.

‘No Decisions’

The husband of real-estate attorney Luce Vela and father of 19-year-old triplets was executive director of Puerto Rico Tourism Co. and secretary of the Department of Economic Development and Commerce. In 2004, he was elected resident commissioner, the territory’s non-voting member of Congress.

Officialdom, he said, should be small and decisive.

“Government often times is afraid of making decisions, so they make no decisions whatsoever,” he said. As governor, Fortuno had little time to dilly-dally.

After his November 2008 victory, he learned the budget gap was more than three times larger than disclosed by the previous administration. As governor-elect, he traveled to Standard & Poor’s and Moody’s Investors Service in New York to dissuade the ratings companies from downgrading the territory’s bonds to junk.

He laid off 12,600 government workers and eliminated more than 7,000 other positions, cutting payroll expenses 17 percent, Carlos Garcia, president of the Government Development Bank, said in an interview.

Mass Walkouts

The firings ignited protests, including a 24-hour general strike on Oct. 15, 2009.

A two-month student strike, which began last year on April 21, shut 10 of the University of Puerto Rico’s 11 campuses. Fortuno’s approval rating stood at 43 percent, according to a Univision Radio poll that month.

Meanwhile, Wall Street cheered. The amount investors charge to take on risk for Puerto Rico’s 10-year general obligation bond compared with Treasuries fell by almost half to 1.6 percentage points Feb. 4, compared with 3.35 percentage points the day he took office, according to data compiled by Bloomberg.

“Puerto Rico’s management through this recession is a model,” said Richard Larkin, director of credit analysis at Herbert J. Sims & Co. in Iselin, New Jersey, which has about $1 billion in assets under management, including Puerto Rico general-obligation and revenue bonds.

Betting on Stability

Standard & Poor’s, which rates Puerto Rico’s bonds one notch above junk at BBB-, cited reductions in payroll spending and the tax measures when it raised its outlook to positive from stable Nov. 29.

“To the extent that they can further improve their collection efforts, I think that only increases their revenue flexibility,” Horacio Aldrete-Sanchez, S&P’s credit analyst, said in a telephone interview from Dallas.

Within three years, the lottery program alone will improve annual collections by $400 million, said Puig, the treasury secretary.

Samuel Sandiego, on whose tray at Church’s Chicken the crumpled receipt lay ignored, said he liked the lottery idea.

“I didn’t realize,” the 45-year-old artist said, putting the receipt in his pocket. A mention of Fortuno’s other policies brought his fist into the air, thumb down. “And I voted for him.”

Hot Dogs, Too

The commonwealth began the lottery pilot program in December in about 200 businesses in Ponce, the second-largest city. Every receipt will be a free ticket for a twice-weekly drawing, said Puig.

All businesses will have a machine, even outdoor kiosks, which have a wireless version. Dixon Diaz, selling hot dogs at his father’s cart in Ponce and handing out receipts, said the business had long paid taxes; others should as well.

Fixing the tax system is a crucial step toward improving Puerto Rico, said Fortuno, who has two years left in his term.

“We must cement our accomplishments” he said. “We have actually walked probably the most difficult part of the road and now it’s just staying the course and making the economy grow.”

Luis Fortuno at a glance:

Born: San Juan, Puerto Rico, October 31, 1960 (Age 50)

Party: Republican, PNP (Partido Nuevo Progresista)

Spouse: Luce Vela, notarial practice/real estate attorney

Children: Triplets, Maria Luisa, Guillermo, and Luis Roberto, born December 11, 1991

Education: Bachelor of Science, School of Foreign Service, Georgetown University, Washington, D.C., 1982; Juris Doctor, University of Virginia, Charlottesville, Virginia, 1985

Financial management: “He’s a very frugal person,” wife Luce Vela said. “I would say he’s stingy, but he says he’s frugal.” He still wears the same tuxedo he wore when he graduated from high school, she said.

Career: Corporate lawyer, McConnell Valdes law firm in San Juan 1985-1992; executive director, Puerto Rico Tourism Co., 1993- 1996; secretary, Puerto Rico Department of Economic Development and Commerce, 1994-1996; private practice attorney 1997-2004; Resident Commissioner of Puerto Rico 2005-2009; elected governor in 2008

Noteworthy: Co-founded the Puerto Rico Statehood Students Association; first Republican governor in 40 years

To contact the reporter on this story: Simone Baribeau in Miami at sbaribeau@bloomberg.net.

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net.

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