Budget Overview Released

WASHINGTON - President Obama's fiscal 2010 budget proposes a five-year, $25 billion national infrastructure bank, a five-year $5 billion high-speed rail state grant program, $4.5 billion for community block development grants, and $3.9 billion for clean and drinking water state revolving funds.

The $3.55 trillion budget request, which was summarized in a 134-page overview released yesterday, would also phase out the Federal Family Education Loan program and require all new student loans to be originated by the Department of Education and financed with Treasury borrowing. That action would effectively kill the market for federally guaranteed student loans, municipal market participants said.

The budget overview does not contain any specific muni bond-related tax proposals, and Obama administration officials said more detailed budget proposals will not be released until April.

But the overview shows that Obama would postpone one of his campaign promises - to raise taxes on the wealthy - until fiscal 2011. Given the current recession, the President did not think it would be prudent to raise taxes at this time, senior Treasury officials said in a briefing.

"There's a general view that we are in a very, very serious recession and the president made a call, which was we are to err on the side of spurring economic demand and therefore nothing that could be seen as a revenue increase, other than enforcement, would start until January 2011," a department official said.


As a result, after rising to a record $1.752 trillion in fiscal 2009, the deficit would decrease only slightly to $1.171 trillion in fiscal 2010. Obama has promised to cut the deficit in half by the end of his four-year term and the budget summary shows the deficit dropping to $912 billion in fiscal 2011 and $581 billion in 2012.

Obama proposes to increase the tax burden for the wealthy in fiscal 2011 by reinstating the 36% and 39.6% tax rates, imposing a 20% tax rate on capital gains and dividends, and reinstating the limitation on tax deductions, according to the budget overview. Wealthy would be defined as married couples earning over $250,000 and individuals earning $200,000 or more.

The 36% and 39.6% tax rates were temporarily repealed by President George W. Bush until 2011. The Obama administration also would cap at 28% the amount of itemized deductions that could be taken by wealthy taxpayers. Normally, the amount a taxpayer can deduct is equal to his or her tax rate. The capital gains tax rate for the wealthy would rise to 20% from the current 15% rate.

In addition, the administration would treat investment income from hedge funds, private equity, and other partnerships as ordinary income rather than capital gains. As a result, taxes paid on that income could nearly double.

Muni market participants said the tax hikes and restrictions on deductions for top wage earners, if enacted for fiscal 2011, could increase the demand for tax-exempt bonds.

"Of course, there is execution risk in that it's only a proposal, but by weakening tax deductions that compete with municipals as tax-shielding strategies, the plan should make munis more attractive to individuals and underwrite more demand for retail-friendly bonds," said Matt Fabian, managing director at Municipal Market Advisors. "And the de-postponement of marginal rate increases doesn't hurt either."

"A key factor for yields in the municipal market is investors' effective marginal tax rates; as they go up the appeal of tax-exempt debt goes higher," said Michael Decker, co-chief executive officer of the Regional Bond Dealers Association.

To further recovery of the financial system, Obama proposes a $250 billion contingent reserve, which would support $750 billion in asset purchases, according to the budget overview.


While the national infrastructure bank would be funded at $5 billion per year for at least five years, the budget request does not detail how the bank would operate, only that it would "help foster coordination" between state, municipal, and private entities while also providing direct federal investment.

The $1 billion per year for five years for high-speed rail would be in addition to the $8 billion provided for high-speed rail under the economic stimulus package enacted into law earlier this month.

Rail stakeholders are expecting stimulus distributions for high-speed rail to give clues about which rail recipients would benefit from the $5 billion proposed by the administration. States and Amtrak are expected to finish pitching their projects for stimulus funding in the next two weeks.

"If it follows the pattern of the stimulus bill, it will be a competitive process," instead of strictly formula funding, said David Johnson, vice president of the National Association of Railroad Passengers.

Early indications are that the $8 billion provided for high-speed rail in the stimulus package will probably be focused on five or six corridors, with somewhere between $1 billion to $2 billion going to each corridor, according to Chuck Baker, president of the National Railroad Construction and Maintenance Association.

"California is probably ... first in line because they have the most well-developed proposal for a new, true high-speed rail proposal, and they're the only state that's committed serious rail money," Baker said.

California voters in November approved a $9.95 billion general obligation bond authorization for rail projects, of which $9 billion will help finance construction of a high-speed train system linking San Francisco and Anaheim, and provisions for future extensions to cities such as San Diego or Sacramento.

"It is definitely true that committing your own funding dramatically increases the chances of Congress being willing to send you some federal funding," Baker said when asked whether bonding like California's would improve a state's chances of securing high-speed rail funds. "But even with California, it's still not 100% clear that the whole system that they've laid out will be built as they've envisioned it."

In addition, the Midwest passenger rail system is likely to "do well" with stimulus funds, Baker added. "Beyond that, it's hard to say. Possibly Florida, possibly the northwest, possibly the northeast corridor," he said.

The budget overview document says the administration "intends to work with Congress to reform surface transportation programs both to put the system on a sustainable financing path and to make investments in a more sustainable future, enhancing transit options." But it does not give any details.

In addition, the budget requests $3.9 billion for clean and drinking water state revolving funds under the Environmental Protection Agency, in addition to the $6 billion provided to the SRFs by the stimulus package.

The president also asked for $1.3 billion in U.S. Department of Agriculture loans and grants to increase broadband capacity and for other projects in rural areas.


The Department of Housing and Urban Development would receive additional funding for programs that can be used in conjunction with tax-exempt bonds. Obama's budget proposal calls for full funding for the community development block grant program, at $4.5 billion, and says it plans to reform the program's formula to better target economically distressed communities. Housing advocates have long argued that the CDBG program has been underfunded.

In a relatively new initiative for HUD, Obama also would provide $1 billion for an affordable housing trust fund to develop, rehabilitate, and preserve affordable housing for very low-income residents. The money could be used in conjunction with projects financed by tax-exempt bonds.

Barbara Thompson, executive director of the National Council of State Housing Finance Agencies, called the trust fund a "breakthrough" for affordable housing needs for the very low-income population.

The trust fund was originally created in the housing recovery legislation signed into law last summer. As it was conceived then, it was to be funded through Fannie Mae and Freddie Mac. However, since the government-sponsored entities have faced their own financial difficulties, the trust fund never had a revenue stream with which to work. The fund now would be financed through the $1 billion allocation from the budget.

"We need these resources to couple with programs like the low-income housing tax credits, like tax-exempt housing bonds," Thompson said. "We don't expect it to do stand-alone project development, but to be used in combination with other resources to facilitate the production of housing for severely low-income residents."

The budget summary says funding for Section 8 housing programs would be increased, but does not give an amount.

In addition, Obama proposes to create a "choice neighborhoods initiative" that would provide federal dollars to support a range of "transformative interventions" in areas with concentrated poverty. The idea is to challenge public, private, and nonprofit partners to "identify neighborhood interventions that would have the largest return on federal investments," according to the overview. But the budget document does not include a price tag or details of how the initiative would work.


In proposing direct lending for student loans, the budget overview stated: "Right now, the subsidies in the government-guaranteed student loan program are set by the Congress through the political process. That program has not only needlessly cost taxpayers billions of dollars, but has also subjected students to uncertainty because of turmoil in the financial markets."

By bypassing private student loan lenders in favor of direct federal lending, the administration "will instead take advantage of low-cost and stable sources of capital so students are ensured access to loans, while providing high-quality services for students" through private loan servicers. The change would save more than $4 billion a year, the blueprint said, presumably through the low cost of borrowing for the federal government.

In a conference call with reporters yesterday, Department of Education officials repeatedly said that the FFEL program is "on life support" and that it's logical for the government to originate all federally guaranteed loans because taxpayers are on the hook for them in the event of default.

"We're changing how we pay loan processors ... instead of paying them with the entitlements that Congress sets, we're paying them through competitive contracts for the servicing and collection on the loans, so it can be serviced-based," said Bob Shireman, a consultant at the DOE.

But Peter Warren, president of the Education Finance Council, said FFEL has "reliably and consistently served as the prime supplier of loan capital for America's students for more than four decades."

The temporary programs that the DOE implemented over the last year to ensure that new FFEL loans were originated "were necessitated chiefly by the current capital markets disruption, which has affected the entire financial services system," he said.

Warren also stressed that taxpayers are only on the hook for the loans in the event of default and that financing all student loans through Treasury debt issuance would increase the federal debt levels by "hundreds of billions of dollars."

Municipal issuers sold more than $116 billion in student loan bonds in the last decade, including $54.9 billion of taxable debt, $34.9 billion of tax-exempt debt, and $26 billion subject to the alternative minimum taxa, according to data from Thomson Reuters.

Obama is also proposing to set aside a reserve fund or more than $630 billion over 10 years that would be dedicated towards financing reforms to the health care system.

Peter Schroeder, Lynne Funk, Andrew Ackerman, Audrey Dutton, and Patrick Temple-West contributed to this story.

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