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Muni Backers Will Fight For Tax-Exempt Interest

WASHINGTON — Municipal market participants warned Wednesday that they would fight any attempts by Congress or the administration to do away with tax-exempt interest for all new municipal bonds.

President Obama’s 18-member, bipartisan deficit reduction commission included the idea as part of an “illustrative proposal” in a 65-page report, called The Moment of Truth, that recommends sweeping reforms of the federal tax code and Social Security, as well as cuts in discretionary spending, and containment of health care costs.

The report’s tax reform proposals would sharply reduce tax rates, abolish the alternative minimum tax, and broaden the tax base while cutting “backdoor spending” in the tax code.

“America’s tax code is broken and must be reformed,” the report said. “In the quarter century since the last comprehensive tax reform, Washington has riddled the system with countless tax expenditures, which are simply spending by another name. These tax earmarks — amounting to $1.1 trillion a year of spending in the tax code — not only increase the deficit, but cause tax rates to be too high. Instead of promoting economic growth and competitiveness, our current code drives up health care costs and provides special treatment to special interests. The code presents individuals and businesses with perverse economic incentives instead of a level playing field.”

Alice Rivlin, a member of the commission who also co-chaired the Bipartisan Policy Center’s Debt Reduction Task Force that released deficit reduction recommendations in November, said Wednesday that both reports propose getting rid of most tax-code provisions that provide various groups with special treatment, such as ending the tax-exempt status for new bonds.

This may be a hard but necessary step to reduce the federal deficit, Rivlin said, adding that she plans to vote for the commission’s final report on Friday.

Rivlin is a senior fellow at the Brookings Institution, founding director of the Congressional Budget Office, former director of the Office of Management and Budget, and former vice chair of the Federal Reserve Board. She is no stranger to the municipal bond market and played a major role in the late 1990s in helping rescue the District of Columbia from financial distress.

But Susan Gaffney, director of the Government Finance Officers Association’s federal liaison center, said that proposing all new munis be taxable, like the tax reforms of 1986, would bring municipal market groups together in opposition.

“This would increase capital costs for governments, in particular small governments, and would dramatically reduce state and local government investment in needed infrastructure,” Gaffney said. “Additionally, the proposal clearly violates the tenets of federalism and, similar to what occurred in 1986, would mobilize the state and local government community as well as other market participants to maintain the tax-exempt status of municipal securities.”

Mike Nicholas, chief executive officer of the Bond Dealers of America, agreed.

“The bottom line is that this would result in increased costs to state and local governments at a time when they are trying to right their financial ships,” he said. “There are other ways to address the federal deficit that we would support, but raising the costs for state and local governments and taxpayers is something we would aggressively attack.”

“The tax-exemption has been the foundation of state and local finance since the inception of the first Internal Revenue Code,” said Michael Decker, managing director and co-head of the Securities Industry and Financial Markets Association’s muni securities division. “Tax-exempt bonds have been the source of financing for much of the nation’s infrastructure. When Congress begins to consider the commission’s recommendations, we believe they should recognize the important role tax-exempt bonds have played in the country’s development.”

John McNally, president of the National Bond Lawyers Association, said taxing new munis not only would increase costs for issuers, but also would not generate additional revenue to address the federal deficit.

“Individuals who buy tax-exempt bonds would simply not buy the newly issued taxable bonds,” he said. “Proposals similar to this have been considered by Congress in the past and each time Congress has properly determined that it is inappropriate and counterproductive to transfer a portion of the federal deficit on the backs of state and local governments.”

State and local transportation officials, however, applauded the report’s proposal for Congress to gradually increase the federal gas tax by 15 cents per gallon between 2013 and 2015, and dedicate the revenues to fully fund the Transportation Trust Fund, limiting spending if necessary to match the revenues collected for the fund each year.

“Congress should limit trust-fund spending to the most pressing infrastructure needs rather than forcing states to fund low-priority projects,” the report said. “It should also end the practice of highway authorization earmarks such as the infamous Bridge to Nowhere.”

“We are ... encouraged that the report emphasizes the vital link between transportation and balancing the federal deficit,” said John Horsley, executive director of the American Association of State Highway and Transportation Officials. “This crucial investment in transportation will pay huge dividends in the form of safer highways and transit systems for generations to come, while creating and sustaining hundreds of thousands of good-paying jobs today.”

The presidential commission’s report paints a dark picture of the nation’s fiscal situation, warning the country faces unsustainable, staggering deficits without major reforms.

This year, federal spending is nearly 24% of gross domestic product. Tax revenues are 15% of GDP and the gap between spending and revenue — the budget deficit — is just under 9% of GDP, the group warned. Since the budget was last balanced in 2001, federal debt has risen to 62% from 33% of GDP. Two wars, a slew of fiscally irresponsible policies, and the recession, have driven the growth, according to the commission.

The panel said its proposals would reduce the deficit by nearly $4 trillion through 2020, more than any effort in the nation’s history. They would lower the deficit to 2.3% of GDP and stabilize debt by 2014, reducing it to 60% of GDP by 2023 and 40% by 2035. Revenue would be capped at 21% of GDP, and spending would be forced down to 22% and ­eventually 21%.

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