Trump's Infrastructure, Tax Proposals Could Affect States, Localities

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WASHINGTON – President-elect Donald Trump's ambitious infrastructure plan and proposed tax cuts will require issuers to adjust to a changing economic climate to maintain credit stability, S&P Global Ratings said Monday.

S&P's public finance group said in a report that the Republican's infrastructure plan, which would use tax credits to leverage private investment, coupled with his tax reform plan, which would lower tax rates, could affect both short-term and long-term economic performance, a "fundamental" credit factor for issuers.

Robin Prunty, an S&P credit analyst who co-authored the report, said that due to Trump's lack of detail in his plans, it is hard to predict whether the election's economic implications will have a positive or negative impact on issuers.

Still, many states are feeling strained from a budgetary standpoint due to a year of slow growth, she said, adding, their ability to respond to policy initiatives will be very important in managing any volatility.

"How issuers in the muni market adjust to the economic climate as well as how they react to changes in Medicaid, we think that's going to be key to credit stability," Prunty said.

In the report, S&P said it continues to anticipate subdued economic growth for 2017, with gross domestic product increasing by 2.4%.

Analysts said that a volatile equity market could especially harm the revenues of states like New York and California, which rely on personal income. Weakening equity markets can also harm pension liabilities by accelerating contributions and creating budget pressures for issuers of all sizes, they added.

"This uncertainty … could exert downward credit pressure across these public finance sectors," the analysts said. "The ability and willingness to adjust to economic volatility, revenue contraction, and potential funding or policy changes at the federal level will be key determinants of credit stability."

"From a credit perspective, we believe changing policy direction or federal funding reductions could represent a material budget impact for states and, to a lesser extent, local governments," S&P analysts wrote in the report.

Trump would use tax credits to support $1 trillion in infrastructure improvements over 10 years. The government would provide a tax credit equal to 82% of the equity amount, which his policy advisors said would lower project costs by 18-20%.

S&P said, however, that a limitation of the tax credit approach is the need for a revenue stream to provide an equity return for investment.

Trump has proposed reducing the current seven individual income tax brackets to three with a top rate of 33%, while also reducing the corporate tax rate to 15% from 35% and repealing the alternative minimum tax. He has proposed reducing tax exemptions and deductions.

S&P, echoing many other market participants, also said in the report that any limit or cap of the current muni exemption would raise borrowing costs, resulting in lower bond issuance and, likely, less infrastructure investment.

Lower infrastructure spending could harm economic growth while also limiting a government's economic competitiveness, they added. Because Trump's tax and infrastructure spending plans are still lacking in detail, they leave questions unanswered.

"How those many infrastructure needs at the state and local level that lack a separate, financeable fee structure would be tackled is unclear," the analysts wrote.

Ed Oswald, a partner with Orrick, Herington & Sutcliffe in Washington, questioned whether alternative infrastructure financing methods could compare favorably to the century-old tax-exempt bond market, which he said is "tried and true," and could more readily handle a large-scale infrastructure plan.

Like many other market participants, Oswald asked for more detail and clarity in Trump's proposals.

"On one hand, it seems to invite large private sector participation and the use of tax credits, and on the other hand references direct-pay and Build America Bonds," Oswald said. "If they are truly thinking about a $1 trillion infrastructure plan, could tax credits and tax credit bonds efficiently absorb that volume?"

In an analysis released by private equity investor Wilbur Ross and UC-Irvine business professor Peter Navarro, both senior policy advisors to Trump, they outlined three problems with the current exemption on municipal bonds. First, they said, equity components or guarantees by creditworthy public authorities are becoming scarcer for lower quality revenue stream projects.

Next, they said that construction costs can be higher in publicly financed projects than private projects.

"These higher construction costs more than offset the benefit of lower interest rates, especially in today's low rate environment when spreads between taxable and tax-free bonds are so small," the advisors said.

Lastly, the advisors argued that proceeds from munis must be spent within a certain amount of time relative to when the bonds were issued, effectively limiting the extent to which the drawdown of the funds can be matched to the construction schedule. This could also mean negative interest rate arbitrage, or losses, of money that a project does not need, they said.

Ross and Navarro said the tax credit financing plan and private investment could serve as a "critical" supplement to existing financing programs, public-private partnerships and Build America Bonds.

Still, Oswald said the likelihood of private entities controlling the nation's infrastructure remains to be seen.

"It's one thing to craft policy and another thing to look to implement it in 50 states with 50 different systems," Oswald said. "Within our system of federalism it's very hard to dictate a one size fits all approach."

 

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