Taxation

Muni Pros Offer Mixed Views on Candidates

OCT 5, 2012 6:30pm ET
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WASHINGTON — Municipal analysts and market participants offered mixed views about how municipal bonds would fare under the tax proposals of Republican presidential candidate Mitt Romney and President Obama.

They were handicapped, in part, because Romney has still not disclosed the details of many of his proposals.

Some market participants contend that Obama’s plans to raise tax rates and permanently reinstate the Build America Bond program would help the muni market, despite his plan to cap the value of tax-exemption at 28% for higher income earners.

They warn that Romney’s proposal to lower tax rates without adding to the federal deficit could be more of a threat because the former Massachusetts governor will have to find more revenue, potentially making munis an attractive target, even though he has never specifically mentioned the muni market.

But several analysts and market participants warned that both candidates’ plans could potentially be disastrous for munis.

“Either party is capable of radical surgery on the municipal bond market,” said Chris Mier, chief strategist and director of the Loop Capital Markets analytical services division. “We really have very few friends in the muni bond market right now from either side.”

Romney and Obama agree that the U.S. tax code is too complicated and needs to be overhauled. Despite that, there are stark differences in how each presidential candidate would tackle tax reform.

Romney wants to cut taxes, broaden the tax base, reduce spending and grow the economy. He has said he will not consider tax hikes.

To pay for lowering marginal rates across the board by 20% and eliminating the alternative minimum tax, he plans to close loopholes and eliminate certain tax preferences so that the amount of revenue the government collects remains the same. But he has not specified which loopholes he would close or which tax preferences he would eliminate.

Romney would permanently extend all the 2001 and 2003 tax cuts now scheduled to expire in 2013. He would eliminate taxation of investment income for individual taxpayers earning less than $200,000.

He also recently announced he would cap individual tax deductions at $17,000, but it’s not clear if he would also cap exclusions, like tax-exemption, as well as deductions. It’s also unclear whether the cap would apply to individuals, married couples or both.

The revenue losses from Romney’s proposed tax cuts would total $480 billion by 2015, according to an analysis by the nonpartisan Tax Policy Center.

Obama, on the other hand, favors extending the 2001 and 2003 tax cuts only for individual taxpayers earning less than $200,000 and for families earning less than $250,000. He would return to Clinton-era top tax rate of 39.6% as a way to boost economic growth.

Obama also is pushing for the “Buffett Rule,” named for Warren Buffett after he said it is unfair that he pays less taxes than his secretary. The rule, introduced by Obama in his State of the Union Address in January, would impose a minimum 30% tax rate on taxpayers whose adjusted gross income exceeds $1 million, including capital gains and dividends.

Increasing tax rates and imposing a 30% tax rate on wealthy individuals could make munis more attractive compared to other forms of investment, market participants said.

Obama also would resurrect the Build America Bonds program, which was created in 2009 under the American Recovery and Reinvestment Act and expired at the end of 2010.

BABs are taxable, but the federal government pays issuers subsidy payments equal to 35% of their interest costs. State and local governments issued roughly $188 billion of BABs under the ARRA program.

The prospect that BABs might be reinstated is much more likely under Obama than Romney because Republicans associate BABs with the president’s stimulus program and oppose them.

They claim BABs generate huge fees for underwriters and encourage issuers with lower credit ratings, like California, to issue more bonds because their higher interest costs give them higher subsidies. 

BABs “would be the greatest benefit in terms of the muni market being stable and strong,” said Tom Metzold, co-director of municipal investments at Eaton Vance. “It creates what is lacking in our market — an institutional arbitrage.”

But in a jobs bill he floated last October and his 2013 budget, Obama proposed to place a 28% cap on the value of tax-exempt interest for the wealthy, an idea that rattled the muni market, especially because it would be retroactively effective if enacted.

While Romney has not specifically mentioned capping tax exemption, in an Wall Street Journal editorial in August, Glenn Hubbard, his senior economic adviser, said the exclusion of interest on tax-exempt municipal bonds is “on the table” for the Republican candidate.

“Under a Romney administration you could see tax-exemption go away completely,” Mier said. “Under an Obama administration you could see the 28% cap applied and another round of BABs.”

Both candidates’ proposals could significantly change the muni market, Mier said, adding that permanently reinstating BABs would be extreme but they have already been done and the market knows how to handle them.

If Romney gets elected and doesn’t eliminate tax-exemption he could be better for muni bonds, according to Mier.

Bruce Bartlett, former policy adviser to President Ronald Reagan and Treasury official under President George H. W. Bush, said without a doubt Obama’s tax proposals would be more beneficial to the municipal market primarily because he wants to impose higher tax rates on the wealthy, which would make tax-exempt bonds more attractive.

Bartlett also said Obama is more likely to give federal aid to cash-strapped states struggling to close large budget gaps.

“Romney will try to dump as much federal spending onto the states and cut their aid,” Bartlett said.

Several market observers suggested that Romney’s 17% cap on individual tax deductions and Obama’s 28% cap are parallel.

Chuck Samuels, a lawyer at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC, noted that if Romney’s 17% cap includes tax-exemption, it may be the beginning of some convergence between the two parties.

“Although a cap would be better than eliminating tax-exemption, it may or may not be better than discrete changes in the tax-exempt bond section of the Internal Revenue Code,” Samuels said. He added that a cap does have a certain equality of treatment to it, although it will “diminish the value of tax-exempt debt and be unfairly retroactive.”

However, he warned, “Once you establish something like that, it is arguably a slippery slope to direct and additional restrictions on tax-exempt bonds.”

Susan Gaffney, director of the Government Finance Officers Association’s federal liaison center, agreed that a cap would lead to further deterioration for the muni market.

 “From a policy perspective, if you are taxing tax-exempt interest under a cap, it could start a slippery slope to something greater down the road to jeopardizing tax-exemption,” she said.

Although higher tax rates and the Buffett Rule would increase investor appetite for muni securities, if the value of tax-exemption were capped, then munis wouldn’t necessarily be more attractive to high-income earners, she added.

Another market observer who did not way to be identified, said: “Changes in the rates and the treatment of interest income for both Romney and Obama would diminish the relative advantage of municipal bonds compared to other investments.”

Obama would tax the interest on existing bonds, the observer said. The need for Romney to find offsets in order to lower tax rates, and the perception that munis only benefit the wealthy, may put the tax-exemption more at risk, he added.

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