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Tax, Spending Increases Mark Proposed FY 2003 Budget

Administration Looks To Simultaneously Avert Deficit, Boost Economy

By CB Staff

February 21, 2002
Copyright © 2002 CARIBBEAN BUSINESS. All Rights Reserved.

Balancing a government’s budget isn’t an easy job in a recessionary economy, which is essentially what the Calderon Administration has faced since taking office a little more than a year ago.

With less money flowing into government coffers as a result of the economic downturn, belt tightening was necessary early on in the administration’s term. The government’s unaudited $542 million year-end deficit for fiscal year 2001 was mostly funded, however, by deficit financing, including restructuring of 2001 debt service payments.

For fiscal year 2002, the administration cut back on spending further, with a 1% reduction in expenditures from the prior year.

Puerto Rico actually isn’t alone when it comes to having a tough time trying to keep its finances in order in the current environment. As Government Development Bank President Juan Agosto-Alicea reminded reporters at La Fortaleza last week, most U.S. states are also facing similar predicaments.

In recent weeks, the governors of Florida, Illinois, Connecticut, Massachusetts, Maryland, and Virginia, for example, have proposed fiscal year (FY) 2003 budgets full of billion-dollar, across-the-board cutbacks in government programs, hiring freezes, and travel restrictions.

The budget Gov. Sila Calderon’s proposed for FY 2003 during her second State of the Commonwealth and Budget Address last week doesn’t include such extreme measures, moving in another direction. Aiming to stimulate the economy and move forward her program commitments, Gov. Calderon’s proposed FY 2003 consolidated budget of $21.8 billion is a full $1.2 billion or 6.3% higher than the Commonwealth’s $20.6 billion FY 2002 budget.

In addition to spending increases ranging from 5.2% to 11.3% at major government agencies such as the Department of Education, Department of Health, Police, and Corrections Administration, the governor has also decided to spend an additional $180 million to cover a $100/month pay raise for approximately 150,000 public employees.

While Calderon did announced 32% lower General Fund spending on administrative expenses such as cellular phones, vehicles, Christmas cards, professional services contracts and Police escorts, the cuts hardly make a dent when it comes to the proposed overall $374 million or 5% increase in General Fund spending (from $7.5 billion in FY 2002 to $7.8 billion in FY 2003).

The governor’s proposed budget ploughs full steam ahead with heavy new spending for public works projects, including $100 million in new spending for projects in the government’s Special Communities program. Altogether, public works spending increases by $256 million to $3.3 billion, an 8.5% increase over the $3.0 billion allocated in FY 2002.

In the course of announcing her proposed $1.2 billion consolidated budget increase for FY 2003, the governor also announced so-called sin tax increases and other special measures designed to generate an additional $598 million in revenue in order to balance the budget.

Gov. Calderon said she opted for the tax increases and special measures as the least painful way of balancing the budget, having rejected other options including seeking new financing or another round of sharp spending cuts. She also said that the tax measures are necessary to close what the administration has termed a recurring structural deficit since 1997.

New revenue-raising measures announced by Gov. Calderon include a proposed $0.50 a pack increase in cigarette taxes and a $0.15 a bottle increase in taxes on alcoholic beverages. The administration projects these two tax increases to provide $200 million in new income, which will be allocated to a special fund to stabilize the health reform program.

The governor also proposes to raise an additional $70 million by making tax rates on 4x4 vehicles equal to those of traditional passenger vehicles. Until now, as Secretary of the Treasury Juan Lopez-Galarza pointed out, 4x4 vehicles have been taxed at an average rate of 15%, while the tax on other passenger vehicles currently averages 24%. This change is expected to cost consumers an average of $1,600 more in the purchase of 4x4 vehicles.

The governor also announced plans to launch new Lottery products–Pega 2 and Pega 4–that are expected to help generate an additional $36 million for the Treasury Department.

Gov. Calderon also said that the third phase of tax reform (reducing individual income tax rates by 1% across the board) would be postponed until 2004, thus saving the government an estimated $116 million.

With respect to the island’s banking and financial services community, certainly the most controversial of Gov. Calderon’s latest proposals is a measure which would allow Individual Retirement Account (IRA) account holders to withdraw up to $20,000 from their IRAs between July and October of 2002 without paying the traditional 10% penalty, and with a 10% withholding tax upon withdrawal, instead of the application of regular income tax rates on the income (which can be as high as 33%).

Treasury Secretary Lopez-Galarza told reporters that the one-time amnesty measure on IRAs is expected to encourage IRA account holders to withdraw an estimated $300 million from their accounts, of a total of approximately $2 billion that Puerto Rico residents currently hold in IRA accounts. The 10% IRA withdrawal tax would thus generate an immediate one-time injection of $30 million to Treasury coffers.

Senior bank executives consulted by CARIBBEAN BUSINESS expressed grave concern over the proposal. Off the record, they indicate that the move stands to damage the integrity of the local IRA system, which unlike its counterpart system stateside, already allows account holders to draw on their accounts for purchasing their principal residence or for educational needs.

"People could cause themselves long-term damage by withdrawing the source of their retirement income," one top banker said. "Here we are trying to help people save for the future, and the government suddenly comes along to encourage them to spend it now, all for a paltry $30 million."

Some industry observers have also expressed concern over how a rash of IRA account withdrawals might impact banks’ third quarter 2002 financial performance.

Infrastructure investment

Responding to critics claiming her administration is not moving enough infrastructure projects ahead, Gov. Sila Calderon announced that during the next four years, total public investment will reach $5.76 billion, creating thousands of jobs throughout the island.

In her address, Calderon announced that for FY 2003, priority will be given to water & municipal projects, the revitalization of urban centers, and the construction of social interest housing.

"We have no doubt that all these projects will come through," Jose Gonzalez Noya, Puerto Rico chapter president of the Associated General Contractors (AGC) told CARIBBEAN BUSINESS. "The different government agency heads involved have demonstrated their interest that these projects get done as expected."

AGC’s 376 local members are responsible for approximately 80% of all construction projects on the island and for providing some 78,000 direct jobs.

Gonzalez Noya said government agencies understand the urgency involved with these projects, and have expressed their confidence in the permitting process.

Water for everyone

Calderon’s infrastructure investment program proposal for FY 2003 includes $804.6 million in 112 projects for the construction of new water treatment facilities and improvements to existing ones, plus the expansion of the Water for Everyone program, with 175 additional projects at a $80.7 million investment.

"AGC’s Water Committee had a very frank discussion with the Water Co. regarding these projects," commented Gonzalez Noya. "The Water Co. has shown great interest to move these projects ahead."

Revitalization of Urban Centers

Calderon has proposed $100 million to be invested in the revitalization of the urban centers in 17 municipalities. An additional $80 million will be invested by public corporations in these municipalities, such as the underground of electrical cables and better illumination, to improve the urban center surroundings.

One example of such projects will be the revitalization of Santurce, where private and public sector investment will create 4,500 new housing units, green areas, plazas, and parking facilities. The government will invest $30 million on land and properties that will be developed by the private sector, creating some 15,300 direct and indirect jobs.

Additionally, $900 million will be invested in 63 projects involving bridges, roads, vocational schools, sport facilities, and other public projects at island municipalities.

"That is a job that deserves praise, of great social interest, that we fully support," said AGC’s Gonzalez Noya, also president of Nogama Construction. "The governor has asked AGC members to form a pool of qualified contractors that want to participate in these revitalization projects and we are willing to do so."

Social Interest Housing

For FY 2003, the Calderon Administration will be providing incentives for the construction of 12,561 social interest (low income) housing units at an $879 million investment, creating 10,538 direct jobs.

Last year, the government began construction of 9,015 of these homes at a $502 million investment, creating 6,025 direct jobs.

The governor expressed her commitment to continue the Keys to Your Home program, proposing $50 million for the program, which provides subsidies of $3,000 to $15,000 toward the down payment of a home for low-income families. According to Calderon, 593 families benefited from the program last year.

Special Communities

Last year, the governor allocated $21.4 million, plus an additional $115 million from government agencies for the special communities. For FY 2003, Calderon requested an additional $100 million for infrastructure funds to benefit special communities, of which the Calderon Administration has identified 686 of them.

Highways, transportation, and public works

For FY 2003, the budget for the Highway and Transportation Authority (HTA) will decrease 13.23% to $157 million, down $24 million from FY 2002’s $181 million.

Meanwhile, the Department of Transportation and Public Works (DTOP by its Spanish acronym) will receive a 15.9% increase, bringing the agency’s budget to $79.2 million for FY 2003, up $10.8 million from FY 2002’s $68.3 million.

"AGC has great faith that the planning involved with all these projects will happen. We need the help of all agencies so that these projects become a reality," said Gonzalez Noya. "We are here to help and serve Puerto Rico and do what needs to be done."

Value of construction down 37.8%

In spite of all the infrastructure projects announced by the governor for FY 2003, Gov. Sila Calderon made public some rather negative news about the local construction industry.

Calderon said that the total value of construction during the first five months of fiscal year 2002 (July to November) experienced a 37.8% drop when compared to same period in 2001. She did not provide the actual numbers.

On a positive note, jobs in construction experienced a 2.1% increase, adding some 1,500 new jobs to the industry, Calderon said.

Cement sales reflected a decrease during the said period, although still remained strong, Calderon said, adding that the sale of 94-pound cement bags averaged 3.5 million a month. This figure compares favorably with sales registered during the beginning of the 1970s, when there was a boom in construction which created a high demand for housing, especially apartments, Calderon said.

Economic development

While some manufacturing industry representatives see the government’s fiscal year (FY) 2003 budget allocation of $473.3 million for economic development and job creation as a positive indicator for the island’s economy, others are taking a wait and see attitude before increasing production.

During last week’s state of the commonwealth message, Gov. Sila Calderon said that at least 20% of her proposed $21.9 billion consolidated budget for FY 2003 will be dedicated to economic development initiatives .

Yet the proposed budgets of key economic development agencies such as the Puerto Rico Industrial Development Co. (Pridco), Promoexport and the Puerto Rico Tourism Co. showed reductions of 54% and 40%, respectively.

While Pridco’s consolidated budget for FY 2003 is proposed at $156.5 million, an 18% decrease compared to FY 2002’s budget of $191.3 million, mostly the result of a 54% cut in capital improvement funds which were slashed from $88.6 million this year to $41 million for next fiscal year.

In the case of Promoexport (the government’s trade development agency now part of the Commerce Development Administration), the agency was assigned $14.7 million in FY 2003, a 14% cut from the $17.1 million assigned in FY 2002. Again, capital improvement funds bore the brunt of the cut, from $6.3 million this year, to $3.8 million next fiscal year.

The proposed budget for the Department of Economic Development & Commerce did rise from $3.2 million in FY 2002 to $8.2 million for FY 2003.

"We will continue creating jobs with our new manufacturing policy, based on industrial clusters. [To this end,] we have assigned $16 million to stimulate these high technology clusters," said Gov. Calderon.

During her address, Gov. Calderon reiterated that her administration would continue the four-pronged economic development initiative implemented during her first year in office. The initiative included the creation of 18 new tax incentive laws during FY 2002 to encourage the expansion of local manufacturing companies and attract new high technology companies to Puerto Rico.

"The Pharmaceutical Industry Association of PR (PIA) has been working with Pridco to maximize the development of [industry] clusters that will identify opportunities within the manufacturing industry, in areas such as supplies, sales, and other related business," said Agustin Marquez, PIA’s executive vice president.

"The 5% increase to [Puerto Rico’s] general budget is positive and a reflection of economic growth. In the case of the pharmaceutical industry, it is solidly established in Puerto Rico and committed to the island’s economic development. This has been seen through the expansion projects announced by Bristol-Myers Squibb, Johnson & Johnson, and Eli Lilly. Within our organization, we are aware of negotiations with the government for additional expansions that reflect confidence in Puerto Rico’s pharmaceutical industry," said Marquez.

During her message, Gov. Calderon linked last year’s passage of the economic development laws to Eli Lilly’s decision to invest $450 million in a new biotechnology facility in Carolina and Shell’s recent acquisition of Sunoco’s refinery in Yabucoa. She also mentioned the local products export law that facilitated Lanco and Pan American Grain’s recent distribution agreements with multinational retail chains.

The governor said that her administration would also carry on with other economic development proposals, such as the reduction of operating costs for businesses in Puerto Rico; minimizing the permit process; and the amendment of Internal Revenue Code Section 956.

Other industries do not foresee increased earnings this year, compared to 2001. Last year was a difficult year because of the economic slowdown but corporation annual reports, such as was the case for J&J, were positive and we expect to do as well this year," said Edgardo Fabregas, Johnson & Johnson operations vice president for Puerto Rico & Latin America. "But we are in a holding pattern to see what happens to the economy, although continuing whatever expansion projects and infrastructure improvements are scheduled for our facilities."

Regarding the creation of new jobs, Gov. Calderon said 3,700 people had been retrained and 1,155 relocated into new jobs during 2001.

"Statistics indicate the creation of approximately 26,000 new jobs during the past year," said Gov. Calderon. "Despite the [economic] situation we confront, during January 2002, unemployment only rose half a percentage point compared to January of last year. These data point toward an economy stabilizing, in the process of recovery."

According to the Department of Labor & Human Resources, the unemployment rate rose to 11.4% in January 2002, 1% higher than January 2001.

Pridco’s recently released statistics for 2001 show that 126 companies opened and 6,049 jobs were created in the island’s manufacturing sector. The areas with the most job creation were scientific instruments, leather goods, and food & beverage. During 2001, 7,553 jobs were lost with a total of 22 company closings.

Health Reform

Confident that financial remedies put in place last year to control the increasing costs of the Health Reform are showing results, Gov. Calderon said that she will continue to search for ways to make this program as cost-effective as possible without sacrificing health services for the populace.

Calderon’s announcement that the $200 million from the increase on taxes on alcoholic beverages, cigarettes, and tobacco will be used to stabilize the Health Reform, or the Health Card, as she referred to the program, was greeted enthusiastically by Puerto Rico Medical Services (ASES by its Spanish acronym) Administrator Orlando Gonzalez. His agency has been assigned a $1.247 billion budget for FY 2003, up $9.9 million from the $1.238 billion assigned for the current fiscal year. The figures indicate that the administration is confident that it will continue to be able to keep Health Reform costs in check.

Calderon said that the medicine acquisition program that was established by her administration last year is already showing results. "The savings will reach approximately $100 million in three years," she declared. Beginning with the new fiscal year starting July 1, the governor said these savings will be passed on to the primary care physicians.

Calderon also announced a series of investments to improve the Health Card. Half or $20 million has been assigned to the development of an Intelligent Health Card, which is basically a high-tech version of the current card used by beneficiaries. To be implemented in July via a pilot program to take place in Isabela, Vieques, and Bayamon, this new card will provide digital access to beneficiaries’ complete medical histories.

While the governor said the smart card will require an investment of $40 million, she predicted it would generate savings of up to $65 million. The second half of the required investment is expected from the federal government. If the pilot program goes well, the governor plans to make the Intelligent Health Card available islandwide to reform beneficiaries by December 2003.

The governor announced plans to invest $5.4 million to provide ambulance services to 37 municipalities that currently lack such service.

Calderon also explained that she wants to monitor referrals to specialists by performing audits in four of the 10 Reform regions on the island starting in April.

"The families that are beneficiaries of the Card should not suffer each time a region changes insurers. During the next negotiations we will extend the duration of contracts with health insurers so families don’t suffer each time providers change," she said.

Calderon also explained that as a first step, she will aim to have the government contract directly with three medical groups, which will look after a minimum of 75,000 patients. By contracting with the doctors, the government believes it will save the expenses incurred when insurance companies serve as middlemen in the contract for services. She also said that she wants to make rates uniform for everyone and to reduce the number of health regions.

Calderon also reiterated that the Diagnostic and Treatment Centers that belong to the health department will stay in the government’s hands and will not be sold. She added that 11 Centers will become Emergency Centers to operate 24 hours a day.

CB reporters Ken Oliver-Mendez, Jose Carmona, Marialba Martinez, and Taina Rosa contributed to this Special Report.

This Caribbean Business article appears courtesy of Casiano Communications.
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