Puerto Rico's economy in limbo after legislators reject governor's tax proposal

Legislators struck down a key part of a plan to overhaul the island's tax system early Thursday, raising concerns about the U.S. territory's economic future and its ability to pay off a heavy public debt.

Legislators voted 28-22 to reject Gov. Alejandro Garcia Padilla's call for a 16 percent value-added tax, and they failed to agree on an alternative way to raise revenues after some nine hours of debate that began Wednesday night.

Garcia issued a sharply worded statement accusing the island's House of Representatives of being irresponsible and warning that economic development could stagnate.

"This action can bring negative consequences to the island's financial stability, putting into danger the continuity of public services, the retirement system, debt payments and health services," Garcia said.

House President Jaime Perello said he will take disciplinary measures against the six legislators of Garcia's party who voted against the measure.

"The island's future is at risk because of them," he said in a statement issued before dawn on Thursday.

The rejection of the measure came just hours before Garcia is scheduled to deliver his yearly state of the commonwealth address amid growing concerns that some of Puerto Rico's public agencies could soon go bankrupt. The U.S. territory is in its eighth year of recession and struggling with $73 billion in public debt.

The island's Government Development Bank recently warned that the government could shut down within three months because of a lack of liquidity if no action is taken.

Economist Gustavo Velez said in a phone interview that the government needs to quickly look for alternatives to help boost the economy.

"This forces us to look beyond the traditional solution of more debt and more taxes," he said. "It forces officials to reduce expenditures and reconsider the size of the government."

He called on the government to reduce expenditures by up to $800 million and said the legislative action means Puerto Rico will likely not be able to issue more than $2 billion in bonds as planned to help raise revenue for the government.

David Tawil, co-founder and portfolio manager of New York-based Maglan Capital, said in a phone interview that investors will be concerned if the rejection of the measure is indicative of something larger, such as political dysfunction.

"If there's no deal anymore and there's no chance for rehashing the one that was voted down, I think there will be a lot of concern, definitely from bondholders," he said. "Now it seems that there is really no direction. I think that will give a considerable chill to the markets here."


Danica Coto on Twitter: www.twitter.com/danicacoto