Puerto Rico Announces 2014 Budget

This week,  Puerto Rico unveiled its first budget in twenty years that did not include borrowing.  The balanced budget was announced by Governor Padilla in conjunction with a roadmap for Puerto Rico's future through 2018. 

Puerto Rico's fiscal year begins July 1st, so none of the announced plans have taken effect yet, but the market for Puerto Rico securities (especially Puerto Rico's recent issuance) responded positively to the news.  Even before the new budget was released, Puerto Rico's bonds had rallied to 90 cents on the dollar from lows around 86 cents.

The budget itself presented a lot of challenges to Governor Padilla – he had previously promised no new taxes (after $1.5 billion in tax increases last year).  Further constraining options was the $6.7 billion in payroll expenses (against a general fund budget of just $9.8 billion), with Governor Padilla promising no new layoffs as well. 

The new budget freezes government hiring, pledges to cut spending by 8% (including a 10% cut in senior staff and professional contract expenses), and combines 25 government entities into a single unit.  While maintaining his pledge of no new layoffs, government employees will face reduced benefits, including sick leave and bonuses. 

Puerto Rico has also been pushing hard to attract wealthy investors to the island.  Its new Law 22 removes all taxes on passive income earned while a resident of Puerto Rico, avoiding (for example) Federal taxes of 23.8% on security sales.  Because Puerto Rico is a U.S. territory, investors would not have to renounce their citizenship, which would trigger a 23.8% exit tax on unrealized capital gains under normal foreign relocation circumstances.

Hedge Fund manager John Paulson (who made billions betting on the mortgage collapse) has been a vocal cheerleader and investor in Puerto Rico, saying that it will become the "Singapore of the Caribbean" at a recent conference he helped organize to attract new investors to the island. 

This strategy is designed to work in tandem with Law 20 in Puerto Rico, which seeks to "encourage local service providers to expand their services to investors outside of P.R., promote the development of new businesses in P.R. and stimulate the inbound transfer of foreign services providers to P.R." by offering a flat 4% tax on export services income.

"We are beginning to pay for today's expenses with today's earnings," reiterated Governor Padilla.  A balanced budget combined with strong growth strategies seems like a step in the right direction.