October 23, 2018
Good Morning! In this morning’s eBlog, we report on Atlantic City’s continued emergence from state fiscal oversight and near municipal bankruptcy, before journeying south to report on Puerto Rico’s similar, ongoing efforts to emerge from PROMESA Board oversight.
The Path to Recovery from State Oversight. Casino, is an Italian fishing card game dating back since 1797 for two, three, four (possibly in two partnerships), or even theoretically five players. It is the only one to have penetrated the English-speaking world. First recorded in 1797, it seems to have been heavily modified, and, in Atlantic City, seeking to emerge from a state takeover, part of the fiscal issue will be the impact on the fiscal recovery of the opening of two new casino properties last summer—and resolving outstanding casino tax appeals. That resolution has worked to lift the City’s municipal bond rating up to the single-B category for the first time in nearly three years, after S&P Global Ratings upgraded Atlantic City’s general obligation bonds to B from CCC-plus late Tuesday, noting a series of improvements accomplished under state oversight, with the upgrade the rating agency’s fifth since its nadir in 2016 as the city hovered on the edge of bankruptcy. The upgrade, too, reflects, according to its analyst Timothy Little, commenting on the decision three weeks ago by Gov. Phil Murphy to continue the state’s oversight of the city’s finances through at least the fall of 2021 under the New Jersey Municipal Stabilization and Recovery Act, with Mr. Little adding: “The upgrade reflects our opinion of the city’s improved operating environment and structural financial improvement following settlement of outstanding tax appeals and continuation of extensive state oversight.” Unsurprisingly, spokesperson Lisa Ryan of the state’s Dept. of Community Affairs, the state agency responsible for managing the state takeover, expressed gratitude for the recognition: “We are enthusiastic about the S&P upgrade, because it demonstrates the hard work being done by Atlantic City and the State is moving the city in a positive direction…Over the last nine months, the city and state have worked collaboratively to find creative solutions to pay Atlantic City’s deferred pension and healthcare contributions and to maintain essential services without significantly increasing the city budget.”
S&P, in its fiscal review, noted that since S&P’s last Atlantic City review, the city achieved permanent financing of its deferred 2015 state pension and healthcare contributions via through a $49.2 million municipal bond sale last April; but the rating agency also credited Atlantic City officials for implementing a 10-year payment-in-lieu-of-taxes program for casino gambling properties and adopting a $225.3 million FY2018 budget which contains less reliance on non-traditional state aid—or, as S&P put it: “The stable outlook reflects our opinion we expect the city to maintain and continue to improve financial performance, increase reserve levels and sustain improved liquidity, while political risk associated with payment of debt service and structural reforms has improved, further lending support to future stability.” Atlantic City Mayor Gilliam noted: “Atlantic City is at a turning point, because we now have a robust road map for the city’s revitalization: As I look around the room and see so many leaders ready to work with the city, I am optimistic for our future. This is an opportunity to try new things to move Atlantic City forward.”
Gambling on the Fiscal Odds? Even before the opening of two casino properties at the beginning of last June, there appeared to be little consensus among industry experts with regard to what their overall impact would be on the existing gaming market: some believed the new properties, the Hard Rock Hotel & Casino Atlantic City and Ocean Resort Casino, would cannibalize the existing seven casinos’ customers, while others were of the mind that more offerings would expand the market. Last month’s casino revenue numbers did little to resolve the issue. Fairleigh Dickenson U. adjunct Professor Bob Ambrose, who focuses om casino management, believes a new competitive environment has been created with the new companies, noting: “Their entry has contributed and broadened the marketplace, not just in gaming, but all areas of hospitality…Tourism benefits by expanding visitors’ options among all properties in Atlantic City, which is so important for marketing the city as a destination.”
Indeed, total gaming revenue in the city, including the new sports gaming, have increased the Atlantic City gaming market: total gaming revenue for last July, August, and September increased by some $123.5 million or 16.5% over last summer. The introduction of internet gaming has also been a revenue gusher: for the selected three months in 2017, internet gaming generated $62.3 million; this year, revenue generated from internet gaming increased $14.2 million, or 22.8%, industrywide. Or, as Rummy Pandit, the Executive Director of the Lloyd D. Levenson Institute of Gaming, Hospitality and Tourism at Stockton University, put it: the revenue figures, coupled with summer transportation data from the South Jersey Transportation Authority, reflect a “very healthy” increase for the market; he added: “In addition to that, what we don’t know yet are the non-gaming numbers,” which he added the New Jersey Division of Gaming Enforcement will release next month, adding: “Those are going to be significantly higher as well, I anticipate, for the third quarter (of 2018) because we’ve increased the number of restaurants, we’ve increased the entertainment, increased the lodging. None of those numbers are reflected in (casino revenue) increase.”
But, as is the nature of gambling, wins or gains are offset by losses—or, as Tony Marino, a local industry analyst put it: because the new entries produced a 20 to 30% increase in the market, he believes it is clear that casino win—total gaming revenue less internet and sports wagering—had decreased since the Hard Rock and Ocean Resort opened, noting that, absent huge increases in internet gaming revenue by Golden Nugget and Resorts Casino Hotel, all seven of the existing casino properties have experienced revenue declines over the three-month period—or, as he put it: “Another way of saying this is that even in the summer months, Hard Rock and Ocean Resort mostly cannibalized the pre-existing brick and mortar market, not expanded it to any great degree…That trend unfortunately may worsen in coming months as we move into the shoulder and winter seasons.” In addition, he warned that another market rightsizing is likely once nearby states, such as New York and Pennsylvania, finalize internet and sports gambling options. Thus, he added: “Most (Atlantic City casinos) will survive by reducing costs through reducing current high levels of employee numbers as low labor-intensive online gaming and sports wagering captures an increasing percentage of total industry gaming revenues…But I also project that the recent boost in visitor numbers will be adversely affected by the twin effects of the trend toward online casino gambling and sports wagering, as well as by competition for visitors from nearby states. Atlantic City will always have strong summer seasons and year-round weekend tourism but not enough to keep all current nine casinos producing positive bottom-line profits.”
Nonetheless, Professor Ambrose believes Atlantic City can thrive if it continues to capitalize on the growth of internet gaming and sports betting: “I look at this past summer as a time of Atlantic City in transition…We need a good year-over-year review, as all properties both new and existing tweak all their options, and adjust their properties to accommodate the new product of sports betting…Moving forward, the Atlantic City market has the potential for continued growth in both gaming and non-gaming as long as there is a balance of marketing and loyalty programs that are realistic.”
Trying to Balance the Cost versus Benefits of Tax Reform. The Puerto Rico Legislature and Executive branch appear to be considering, again, the concept of cutting industrial incentives and tax credits to save money and cover a large part of the $209 million shortfall projected from the current tax reform proposal. That proposal does not imply that the Legislature will finally give way to the creation of the so-called Incentive Code, which has remained in a kind of legislative Twilight Zone since last June, and which, to date, appears to lack the requisite number of votes in the legislature to pass. The tax bill, developed mainly by the Department of Economic Development and Commerce, in addition to proposing fiscal incentives in a single statute, includes a series of performance metrics and provides for government investment in different industrial sectors to be limited. Nevertheless, according to Puerto Rico Treasury Secretary Teresita Fuentes, the pending proposal now also proposes a limit on the amount of fiscal stimulus the government may invest annually to encourage an industrial sector, stating: “I do not know if there is enough time to approve the Incentive Code. It’s quite possible that we will end up reviewing the caps of each incentive. We are analyzing all of them.”
If anything, the taxing challenge confronts another obstacle: private sector leaders look on cuts in tax incentives with suspicion. Originally, the fiscal plan certified by the PROMESA Oversight Board, based on the Incentive Code proposal, imposed cuts on investments in agriculture, the film industry, tourism, manufacturing, rum, and hospitals, among other economic sectors—proposed cuts which drew the opposition of a large part of the local business community. Sec. Fuentes did not specify how much in appropriations will be cut via the proposed caps, stating that the issue would be resolved in the wake of studying the economic effect of each possible change in the laws that promote several industrial activities. Moreover, she added, this would not be the only initiative to reach the level of revenues of recent years, as required by the PROMESA Board; there will also be rate adjustments of different taxes to ensure compliance with the budget neutrality of the reform in government revenues. Similarly, House Finance Committee Chair Antonio Soto has noted there would be less corporate tax relief than initially proposed by Governor Ricardo Rosselló Nevares, stating: “We are reviewing all the laws, and we are in conversations with (the Department of) Economic Development and the Legislature. There are laws with high caps that do not necessarily have the highest ‘return of investment.’”
The tax discussion has, unsurprisingly, left the business community non-plused: Puerto Rico Chamber of Commerce President Kenneth Rivera Robles warned that just the rumor that tax incentives will be modified can stop or discourage investments in Puerto Rico: “It can stop economic activity. Instability can have the effect of losing investment.” His counterpart, Rodrigo Masses, President of the Manufacturers Association, stressed that reducing corporate welfare programs in order to lower income taxes has a fundamental problem; he fears it would discourage production, but encourage consumption, noting that, with the reform, companies in areas such as manufacturing, where products that generate capital or wealth are created, would have fewer resources to operate and would be in a worse position in terms of competitiveness. In contrast, trade, which is where the money is spent, would be encouraged as taxes on income and consumption would be reduced—or, as he put it: “And production is what allows us to develop the wealth so that the island can consume…I would be very sad that something like this would be approved at the expense of the productive sectors of Puerto Rico,” stressing that currently the production by Puerto Rico’s manufacturers generates much more than the 30% of the net income of the General Fund.
Modifying Puerto Rico’s Property Tax. The proposed elimination of the portion of the island’s property tax which applies to inventories and those initiatives associated with the video lottery, as recently agreed at a meeting between the Executive branch and House and Senate leaders, is, nevertheless, not included, but rather still under consideration—or, as Sec. Fuentes noted: “(The video lottery) is not being considered in numbers,” referring to one of the main House proposals to bring in more revenues to the Treasury. Nevertheless, the lottery issue appears to be a difficult issue creating disagreements not just in New Jersey, but now between the Governor, House, and Senate, because the parties have been unable to achieve consensus on how to allocate the projected revenues: House President Carlos “Johnny” Méndez wanted to use the funds to cover what municipalities would not receive by eliminating the tax on inventory. Senate President Thomas Rivera Schatz supports using the funds to finance the mandatory municipal contribution to the Government Health Plan, now called Vital, while the Governor has supported directing the funds to finance the Christmas bonus for public employees. The House insists that the legalization of video lottery prizes should be included in the reform, said Soto. The elimination of the tax on inventories, meanwhile, would be worked on in a separate bill. Chairman Soto notes: “We are working on several alternatives to address the issue in a separate bill.”
Nevertheless, the different sides appear to be making progress: Gov. Rosselló Nevares’ original proposal reduced income tax rates for individuals and corporations, lowered Sales and Use tax rates on prepared foods and business transactions, and establishment of a work credit. If the tax reform were approved, the sales and use tax on prepared foods would be 8.5%: the goal is to eventually lower it to 1.5%. In the meantime, the goal is to eliminate the business-to-business sales and use tax within three years.
In theory, the reform will increase taxes on those who are self-employed and small businesses which do not have to submit financial statements with their returns. This would be achieved by requiring evidence or certifications associated with the deductions that, usually, these taxpayers claimed in the returns. If a taxpayer does not want or cannot justify his or her deductions, she or he could benefit from an alternate calculation of their tax burden based on the gross sales of his company.