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All Eyes On Deficit Committee

WASHINGTON — State and local groups are sizing up the new congressional deficit reduction committee, determined to preserve tax-exemption for municipal bonds but acknowledging that federal funds for some of their programs will likely be cut.

Officials within the tax-exempt community’s lobbying circle are working on two fronts: to defend tax-exemption for muni bonds, while maneuvering to win compromises from seemingly inevitable cuts to state Medicaid funding and other federal programs.

For now, uncertainty reigns. Some observers doubt the committee will ultimately agree on anything and said tax code changes will probably not be recommended, especially within the brief window the committee has to operate.

The 12-member, bipartisan and bicameral “super” committee, borne out of the debt ceiling agreement, is tasked with finding at least $1.2 trillion in deficit reduction over 10 years. Its recommendations are due to Congress by Nov. 23 and lawmakers must vote on them no later than Dec. 23. If the panel cannot come up with a plan that can be enacted by Jan. 15, 2012, automatic spending cuts to both military and non-military discretionary spending will take effect beginning in 2013.

“This committee needs to make a fundamental decision, which is: does it want to do revenue-neutral tax reform or does it want to do tax reform that raises revenue?” said Howard Gleckman, a resident fellow at the Tax Policy Institute.

“It doesn’t appear to me that this committee is prepared to do that,” he said, adding that he’s “quite skeptical that they’ll reach any sort of agreement.”

Though the Obama administration is hoping the committee will include recommendations to raise revenue, Republicans are vehemently against tax increases. All six Republican members of the deficit committee have signed the Americans for Tax Reform pledge swearing off new taxes.

Rep. David Camp, R-Mich., a member of the super committee who also chairs the House Ways and Means Committee, believes any tax reform proposals should be the purview of his panel, not the deficit reduction committee, a staffer said Tuesday.

With the focus on spending cuts, curbs to tax-exempt munis could be swept up among cuts to other federal expenditure programs, sources said.

Further, Republicans may look to end the tax exemption as a way to appease Democrats eager to raise revenues, but without increasing taxes, said John Buckley, a professor at Georgetown University Law Center and former chief tax counsel for the House Ways and Means Committee.

“Tax exemption is the one area where it looks like a big tax increase on the wealthy when it is not,” he said. “It affects state and local governments much more than it does the individual investors.”

“This is one of the few tax increases that makes it look like your hosing the rich when in fact you’re really hosing state and  local governments,” Buckley added.

Among Democrats, the muni tax exemption has had advocates both in the House and Senate. Two super committee members, Sens. Max Baucus, D-Mont., and John Kerry, D-Mass., have been allies of the state and local community in the past, sources agreed.

Kerry has proposed pending legislation that would create a national infrastructure bank.

There is a lot of support on the Democrat side “for helping state and local governments,” Buckley said. He said the committee’s House Democratic members — James Clyburn of South Carolina, Chris Van Hollen of Maryland and Xavier Becerra of California — also clearly understand the importance of tax exemption.

Support from Republicans for state and local interests is less clear. Analysts with Municipal Market Advisors wrote last week that the super committee “does not feature any opponents to tax exemption.”

Camp has criticized BABs as “a heavily subsidized spending program,” and Sen. Jon Kyl, R-Ariz., another committee member, played a key role in keeping extensions of BABs and other American Recovery and Reinvestment Act-related bond incentives out of a tax bill that extended the Bush tax cuts and was enacted last year.

Sen. Pat Toomey, R-Pa., another panel member, has pushed for Congress to enact comprehensive tax reform that lowers the marginal rates, broadens the base and simplifies the tax code.

With the emphasis trending toward spending cuts, state and local groups are hoping a give-and-take approach will help offset federal program cuts. They seem willing to negotiate for more flexibility to use less federal money, but want to protect low-income programs.

“Our members expect that there’s going to be some discretionary accounts that are either going to disappear or be trimmed significantly over 10 years,” said Michael Bird, senior federal affairs director for the National Conference of State Legislatures. “I think [states] are aware that cuts in the Medicaid program are going to happen.”

States are looking for relief from certain Medicaid requirements and are also advocating for statutory, counter-cyclical assistance.

When the last recession hit, the federal government boosted Medicaid matching in the ARRA.

Bird said states would like to see enhanced federal coverage automatically triggered if another recession hits.

The trade-offs “would help balance what appear to be almost for-certain reductions in the Medicaid program,” Bird said.

For local governments, any federal reduction in spending may blunt the faltering recovery in their economies, especially concerning property taxes, which provide the bulk of their revenue.

“Any time there is a reduction in federal spending, we know it is going to trickle down to the local level because the states are going to cut back as well,” said Michael Belarmino, associate legislative director for the National Association of Counties.

A double-dip recession combined with federal spending cuts is “tying both hands behind your back,” he said.

Standard & Poor’s issued a report Thursday warning that the longer-term deficit reduction framework adopted in legislation earlier this month “could undermine the already fragile economic recovery and complicate aspects of state and local government fiscal management ... potentially weaken[ing] our view of certain individual credit profiles of obligors across the sector.”

Though it is unclear what the committee will recommend, it is likely that tax-exempt bonds will continue to face increased scrutiny from Congress.

“Lawmakers are going to increasingly affect the municipal bond market,” said Tom Kozlik, vice president and municipal credit analyst at Janney Montgomery Scott LLC. “They giveth and then they taketh away.”

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