WASHINGTON — Tax reform proposals to curb tax exemption for municipal securities would create uncertainty in the market, possibly lead to higher borrowing costs, and hurt infrastructure development, issuer and borrower groups warned a Senate Finance Committee working group this week.
The groups emphasized the importance of the municipal bond tax exemption in two papers sent this week to the committee's tax-reform working group on community development & infrastructure, one of five such groups that are supposed to make recommendations to the full committee by the end of May. The working group is led by Sens. Dean Heller, R-Nev., and Michael Bennet, D-Colo.
One paper is from the National Association of Counties, the National League of Cities, the U.S. Conference of Mayors, the International City/County Management Association and the Government Finance Officers Association. The other is from organizations including the American Association of State Colleges and Universities, the American Hospital Association and the National Association of Health and Educational Facilities Finance Authorities.
If the proposal in President Obama's budget to cap the value of the muni exemption at 28% had been in place from 2003 to 2012, state and local governments' interest expenses for infrastructure projects would have increased by $173 billion, according to a 2013 report from some of the local government groups that was included as an appendix to their letter.
"Without the exemption, the fate of national infrastructure financing will be uncertain, causing infrastructure construction and maintenance to stagnate," the local government groups said in their paper, noting that direct federal assistance to support infrastructure is shrinking.
The hospital and higher education groups issued a similar warning. "Higher borrowing costs can result in diminished investments in infrastructure, higher costs, fewer jobs, reduced public services, and increased charges and fees," they said in their paper.
Proposals to replace tax-exempt bonds with traditional tax credit or direct-pay bonds would also create uncertainty in the market and would raise borrowing costs for most governments, particularly the smaller ones, according to the local government group letter.
Congress should view direct-pay bonds as a complement to tax-exempt bonds, rather than as an alternative to them, the hospital and higher education groups said.
Those groups said they generally would support direct-pay programs "if they are designed with subsidies adequate to result in a financial instrument whose total costs are comparable with a tax-exempt bond." They want Congress to allow Build America Bonds to be used by nonprofits if the lawmakers reinstate BABs. Nonprofits could not use BABs in 2009 and 2010.
Both papers stressed the benefits of tax-exempt bonds.
"Through the tax-exemption, the federal government continues to provide critical support for the federal, state and local partnership that develops and maintains essential infrastructure, which it cannot practically replicate by other means," the local government groups said.
While critics have argued that the exemption mainly benefits wealthy investors, the true beneficiaries of munis are state and local governments that need investors to help them finance infrastructure, taxpayers who depend on the infrastructure, the federal government and investors who buy bonds, the local government groups said.
They added that, according to 2010 Internal Revenue Service data, 57% of tax-exempt income was reported by earners over 65, and 52% of muni interest was paid to individuals went to people with incomes of less than $250,000.
The hospital and higher education groups urged Congress to protect tax-exempt bond financing, including the exemption for qualified 501(c)(3) private-activity bonds, which finance the projects of nonprofit colleges and hospitals.
The lower interest rates on munis compared to taxable bonds are beneficial for borrowers, the hospital and higher education groups said. "For many institutions, public or private revenue from operations or from restricted gifts simply does not provide enough funds to build, expand, and renovate the physical plant, property, and equipment needs, and taxable debt is more costly," they said.
The local government groups also urged Congress to modify the 2% de minimis rule for financial institutions and increase the bank-qualified debt limit to $30 million from $10 million.
Under current tax law, only corporations that are not financial institutions can deduct most of the cost of buying and carrying any kind of tax-exempt bonds, to the extent that their tax-exempt holdings do not exceed 2% of their assets. Financial institutions can only take the deduction for bank-qualified bonds, which can only be issued by state and local governments that sell no more than $10 million of tax-exempt bonds per year.
Additionally, the local government groups asked the working group to preserve the state and local tax deductions. They also want Congress to pass the Marketplace Fairness Act, which would allow states to require out-of-state online retailers to collect their sales taxes if the states simplified their sales tax laws.
