New tax reform legislation unveiled Tuesday by Sens. Ron Wyden, D-Ore., and Judd Gregg, R-N.H., would eliminate tax-exempt bonds beginning in 2011, change the tax exemption for state and local bonds to a tax credit, and prohibit the advance refunding of bonds.
Market participants immediately announced their staunch opposition to the bill — whose sponsors said it is modeled after “the successful” Tax Reform Act of 1986 — and said it’s unlikely such a drastic overhaul of the municipal market would become law.
“That’s definitely something that we would and will oppose,” said Mike Nicholas, chief executive officer of the Regional Bond Dealers Association. “Moving all munis to a tax-credit structure is definitely not something we would support. It’s moving in the wrong direction.”
“Our experience over the last year or so with tax-credit bonds suggests that that’s not really an effective way for the federal government to assist in state and local borrowing,” said Michael Decker, managing director and co-head of the Securities Industry and Financial Markets Association’s muni securities division. “To replace a proven and effective means of borrowing with one that’s proven to be really ineffective would be a mistake.”
Susan Gaffney, director of the Government Finance Officers Association’s federal liaison center, also opposed the bill, warning it would adversely impact nearly every city, county, and state across the country at a time when their “needs are so great.”
“The approval prospects for that part of the bill would be dim,” agreed Matt Fabian, managing director at Municipal Market Advisors.
Wyden and Gregg rolled out the Bipartisan Tax Fairness and Simplification Act of 2010 yesterday, calling for a drastic overhaul of the current tax system, which they said is “broken.”
Specifically, the bill stipulates that muni bonds issued beginning in 2011 would be taxable and holders would receive a tax credit equal to 25% of the bonds’ interest cost. That credit rate would be well below those of the existing tax-credit bond programs, which range from 70% to 100% of interest cost. An aide to Gregg indicated that Wyden, who sits on the Senate Finance Committee was the force behind the provisions eliminating tax-exemption for new bonds.
The proposed wholesale shift to tax-credit bonds comes as Congress is moving forward with a jobs bills that would modify certain tax-credit bond programs that have struggled to gain a foothold in the market by allowing issuers to receive a direct subsidy payment from the federal government instead of providing investors with a tax credit.
Wyden sponsored the original legislation creating the first direct-pay bonds — Build America Bonds — that was eventually added to the American Recovery and Reinvestment Act. However, the Wyden-Gregg bill is silent on BABs, leading some market participants to question the future of the program, which is slated to expire at the end of the year.
The lawmakers clearly believe the bill is a spiritual successor to the Tax Reform Act of 1986, which contained the most stringent restrictions ever imposed on tax-exempt bonds, including broad arbitrage rebate restrictions, the private-activity bond volume cap and limits on the amount of bonds that banks could buy.
“Overall, the [bill] follows the successful model of the bipartisan Tax Reform Act of 1986 which funded tax relief by eliminating a number of special interest tax breaks,” the two stated in a release.
Market participants speculated yesterday that the bill includes the massive shift to tax-credit bonds as a way to save money for the federal government. Economists have long argued that tax-exempt bonds are an inefficient way to subsidize state and local projects, and tax-credit bonds would offer the federal government better bang for its buck.
Neither the lawmakers nor their staff could be reached for comment.