Puerto Rico’s statehood would kill its triple bond tax exemption

0


If Congress makes Puerto Rico a U.S. state, it would impact both its finances and its debt stock both positively and negatively, analysts say, but losing the triple tax exemption would shrink its buyer base for many. future transactions.

In November, 52% of voters in Puerto Rico voted for the creation of a state in a non-binding consultative referendum and currently, two bills in Congress could lead to the creation of a state.

This is of course not the first time the question of state for territory has arisen – the November vote was the sixth status referendum since 1967 – and it never gained enough momentum in Washington. to materialize.

The flags of the United States and Puerto Rico fly outside the territory’s capital in San Juan. A change of status to state would have implications for Puerto Rico’s debt.

Bloomberg News

This year, the idea has garnered more widespread attention, both positive and negative, as Washington, DC’s statehood is also on the table.

One of the most important effects of Puerto Rico’s statehood would be the loss of its unique triple tax exemption. New bonds sold by a Puerto Rican state would not benefit from the tax exemption from local, municipal, and federal taxes that have historically attracted many US investors to the island’s debt.

Only those who reside in Puerto Rico would still benefit from state and municipal income tax exemption on interest on bonds should it become a state. There is no precise public figure, but in recent years it has been estimated that residents of Puerto Rico own 20% of Commonwealth bonds.

Aside from the loss of the triple tax exemption, “it is difficult to see that Puerto Rico is in a worse position, or less able to raise capital, if it were a state compared to the current status. Said Matt Fabian, partner of Municipal Market Analytics.

“We find it hard to see the state of Puerto Rico as a negative scenario for bondholders, arguing that a significant part of Puerto Rico’s past financial and economic woes reflected Puerto Rico’s pervasive reliance on a US Congress selfless and uninvolved, ”analysts wrote on April 19. MMA Outlook. “Further, any transition from a territory to a state would require substantial fiscal and administrative reforms and would reasonably involve years of preparation.”

After the state was established, bond investors off the island would be less interested in Puerto Rican bonds, said Bob Chirinko, professor of finance at the University of Illinois at Chicago. To attract investors, Puerto Rican government issuers would have to pay higher interest rates than they would otherwise. Puerto Rico would already pay a premium given its fiscal turmoil.

Future issuance has less to do with statehood than debt capacity, rating potential and economic growth, one bondholder said.

“Buyers would be as they are in the muni market today, for most traditional investors, although they are no longer three times tax exempt for all buyers, so spreads would be higher,” said the bond holder. “But that’s going to be a problem they’ll face because of fiscal health anyway.”

Losing the triple tax exemption would eliminate the municipal bond funds’ demand for a single state to hold Puerto Rican paper. These funds are structured to maximize the state and federal tax benefits of their buyers.

Some held up to 40% of Puerto Rico’s debt before the Commonwealth entered Title III, although anecdotally those numbers have come down from pre-bankruptcy peaks.

As for the existing Puerto Rican bonds, they would likely see their tax exemption for state-side residents, which would also make them rarer and more valuable. If the bonds were refinanced, the triple exemption would not be allowed.

“Remaining exempt by the federal government [after statehood] seems the most likely, but legal advisers should verify that all Puerto Rican bonds comply with all of the terms of the traditional tax exemption section of the code, ”Fabian said.

For others, the future of bonds is more mixed or dependent on undefined factors. One analyst said all new Puerto Rican bonds are likely to carry high interest rates over the next several years until “the credit situation is fully restored.”

Even before the state is implemented, Puerto Rico is expected to come out of bankruptcy.

According to the Puerto Rican Surveillance, Management and Economic Stability Act, Puerto Rico must have a structurally balanced budget for four years before the board can get rid of itself and give way to local rule. . The government cannot even have its first structurally balanced budget until the central government debt deal is approved and it begins to make debt service payments on the restructured debt.

Before Puerto Rico becomes a state, Congress would either have to observe the four-year period or modify PROMESA. A state government cannot be under the control of a federally appointed council.

Chirinko said PROMESA is the state’s “wild card” because “its existence appears to be based on Puerto Rico’s unique territorial status”.

The question of how pre-state obligations are handled after statehood has precedents.

Matt Fabian, municipal market analysis partner, said any transition from Puerto Rico to statehood will be long.

Congress made Hawaii a state through the Hawaii Admissions Act in 1959, which specified that territorial laws were to be transferred into state laws. This law meant that the federal government continued to observe Hawaii’s bond tax exemption in the decades that followed, said William Yuen, associate of the Honolulu branch of Dentons.

In 1964, the California Franchise Tax Board ruled that interest on Hawaiian and Alaskan bonds issued before statehood should remain exempt from California taxes.

In 1914, the United States Supreme Court suggested that pre-state Oklahoma bonds should retain their tax exemption from other state income taxes.

Some observers have said statehood could benefit outstanding bonds. Arturo Porzecanski, Hurst lecturer at the American University, said the creation of a state would make obligations more secure since federal law prohibits states from declaring bankruptcy.

If Puerto Rico became a state, it “would benefit in many ways from existing federal programs that reallocate resources from richer states to poorer states,” Chirinko said.

Rating agencies could potentially improve Puerto Rico’s outstanding debt due to stronger fiscal ties with the federal government.

In a comment published on November 4, Moody’s Investors Service made a similar point. “Providing adequate funding under the Medicaid healthcare program is a long-standing credit challenge for the Commonwealth,” said Vice President Geneviève Nolan and five other analysts. Becoming a state would convert ad hoc congressional aid into mandated aid and increase the federal contribution.

Puerto Rico would be eligible for the federal supplemental nutritional assistance program and supplemental income security programs and it would get more money for Medicare, Moody’s said.

If Puerto Rico became a state, islanders would have to start paying federal income taxes. However, nearly 80% of them would fall into the two lowest federal tax brackets of 12% or less, Moody’s said.

“Some business investment… could increase because of the greater perceived political stability stemming from statehood, as opposed to Puerto Rico remaining a territory,” Moody’s said.

The impact of statehood on bonds could however be theoretical in the near future. Several analysts have said that state creation is unlikely to happen anytime soon.

“I am skeptical that there is sufficient political will for the establishment of a state in Congress and I think this is likely to happen only if [Washington,] Washington State, ”said the bondholder.

Others said the political climate in Washington also throws a key in the creation of a state for the island. [by its people] must be complemented by a positive vote in both houses of the US Congress, “Chirinko said.” Republicans are unlikely to be in favor of giving Democrats about six electoral votes. “

In addition to electoral votes, statehood would give Puerto Rico two US senators and four members of the US House of Representatives. Currently, there is only Jenniffer Gonzalez Colón in Congress. She can vote in committee but not in the House.

Porzecanski said Congress would have to be “comfortably in the hands of Democrats” for at least four years for a Puerto Rican state bill to have any chance of passing. Additionally, DC would likely have to become a state first before granting that status to Puerto Rico. Others noted that Puerto Rico is expected to come out of bankruptcy.

The state may not be the only possible new status for the island. Some islanders say Puerto Rico should be an independent nation and others say it should have semi-independent affiliate status. One of the bills currently in Congress that could lead to the creation of a state, drafted by Representative Nydia Velazquez, DN.Y., would have the inhabitants of the island elect delegates to a convention on constitutional status to choose from several status options.



Source link

Leave A Reply

Your email address will not be published.