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Tax-Exemption Efforts Send Lobbyists Scrambling

JUN 17, 2011 6:55pm ET
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WASHINGTON — State and local government groups are launching campaigns to protect the tax-exempt interest for municipal bonds against cost-cutting efforts in Congress.

Lobbyists representing states, cities, development banks, and other muni issuers are eyeing an upcoming debt-ceiling resolution as a possible showdown in which tax expenditures could be threatened. These issuer groups are also watching the fiscal 2012 budget proceedings as an avenue for lawmakers to cut tax expenditures as a way to rein in the federal deficit.

The tax exemption for munis has drawn scrutiny from both Democrats and Republicans so the outreach effort crosses party lines, sources said. Democrats believe the tax exemption for municipal bonds benefits wealthy individuals. Some issuer groups said they worry a cut in the tax exemption may be an easy point of compromise for Democrats.

The new Republican majority in the House, bolstered by many Tea Party members from last November’s election, are looking at cuts in tax expenditures to bring down the income tax rates as part of broader tax reform The new Republican members need to be educated on the importance of municipal bonds, sources agreed.

In meetings with members of Congress and their staffs, issuer groups have said they have often received conflicting messages about the degree to which the tax-exempt status of munis is threatened. The possibility of an all-out end to the tax exemption is minute, given the political backlash and fear of unintended consequences, but Congress could take a more nuanced approach, sources said.

Additionally, a Senate vote Thursday to end an ethanol tax credit, a well-entrenched subsidy, rattled muni market participants who are still nervous over recommendations in the report from President Obama’s deficit commission, which called for an end to tax exemption for new munis.

The tax exemption issue is “a huge deal,” said Ben Watkins, director of Florida’s Division of Bond Finance, who said he is preparing, in letters and meetings, to educate Florida’s congressional delegation about this issue. The issuer community “needs to be vigilant,” he said.

Two weeks ago, about a dozen issuer advocates met with staff members for Democrats and Republicans on the Senate Finance Committee to emphasize the important role tax-exempt bonds play in infrastructure development.

The issuer groups were told by staffers that the tax exemption of muni bonds was on the table as part of discussions on spending cuts, and that the committee may soon schedule hearings on this subject, sources involved with the meeting said.

“State and local [governments] know there is no new money coming from the federal government; it’s concerning if tax-exempt bonds are at risk here,” said David Parkhurst, director and legislative counsel for the National Governors Association who declined to comment directly on discussions with members on Congress about the issue.

“Tax-exempt [bonds] really become the last remaining tool in our toolkit, absent federal money, to invest,” he said.

One complicating factor for the issuers’ efforts is that their lobbying efficacy may not be as laser-focused as other interest groups, sources said. With various interests, ranging from large and small governments to nonprofit organizations, tax-exempt advocacy has been challenged in the past with finding its voice.

The issuer community in Washington “is not as active as other industries in making the case for preserving the tax-exemption,” said Derek Dorn, a partner with Davis & Harman LLP and until earlier this month a senior financial counsel to Sen. Jeff Bingaman, D-N.M. Other interest groups “have been more vocal in the need to preserve their favored tax status,” he said.

Advocacy before members of Congress “is where state and local governments have not been very effective,” said John Buckley, a professor at Georgetown University Law Center and former chief tax counsel for the House Ways and Means Committee.

But the tax-exemption issue may be coalescing the issuer groups. At the Senate Finance meeting, groups “were singing from the same hymnal,” one participant said.

Both Dorn and Buckley agreed the debt ceiling resolution probably will not be the stage for ending the tax exemption.

“It seems highly unlikely that efforts to curtail tax expenditures in any debt ceiling exercise, if in fact successful, will impose limitations or cutbacks on the existing exemption for debt issued by municipal governments,” Dorn said. “The debt ceiling negotiators would opt for less politically sacred tax expenditures.”

“I’m not convinced that anything on the revenue side gets done on the debt limit,” Buckley said, but added that state and local governments “have a good reason to be concerned” for the tax exemption.

This concern stems from the President’s National Commission on Fiscal Responsibility and Reform, which was released in November and proposed an end to the tax exemption as part of overall tax reform.

The tax exemption “was kind of at the top of the list” in the deficit commission’s report, Buckley said.

For issuers, the education continues. Toby Rittner, president and chief executive of the Council of Development Finance Agencies, said his legislative committee Thursday held a meeting with representatives from 25 states to prepare an advocacy campaign in the next six weeks. “We are gearing up for this,” he said. CDFA members “live and breathe off of tax-exempt bond issuance” and “they can’t really do their job if the tool is eliminated,” he said.

Joan Quigley contributed to this story.

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A recent phenomenon is the emergence of bonds with shorter call protection as funding alternatives for municipalities. However, the shorter call protection also dampens the potential upside for investors, which in turn reduces the price they are willing to pay.

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