WASHINGTON – While most muni market participants agree that 2017 could be the year of comprehensive tax reform, they have mixed views on whether the muni exemption is safe under the tax proposals of President-Elect Donald Trump and House Republicans.
Both Trump and House Republicans have introduced tax reform plans that would lower individual and corporate tax rates as well as broaden the tax base. The plans would repeal or restrict tax deductions and exemptions. Neither mention munis specifically, though Senate Finance Committee Democrats claim the Republican plan would do away with the exclusion for tax-exempt interest.
Trump recently told some of the nation's mayors, members of the U.S. Conference of Mayors (USCM), that he supports the tax exemption for munis. They met with him at Trump Tower in New York in December and they hope they can take him at his word.
"Nothing at this point is telling us that we're safe," said Michael Belarmino, associate legislative director and associate general counsel for the National Association of Counties (NACo). "We keep hearing that everything is on the table. We're going to stay vigilant and engage the House and the administration."
During the nearly two months since President-elect Donald Trump was elected, market groups have expressed concern over the future of the tax exemption of munis due to the Republican's lack of detail in his tax proposal.
Those concerns were temporarily quelled earlier this month after Trump told representatives from the USCM that he supports the tax break used to provide low-cost borrowing for state and local governments for more than a century. While muni groups were encouraged by the news, they said they will still remain vigilant in lobbying for the exemption on the Hill.
"Until we see it set in stone that the exemption is maintained we're going to continue to educate and promote our desire for the exemption to remain intact," said Jessica Giroux, general counsel and managing director of federal regulatory policy for Bond Dealers of America.
Emily Brock, director of the Government Finance Officers Association's federal liaison center, who called the start of the new administration a "hectic and exciting" time, said GFOA will continue to stress the importance of the exemption in providing for low-cost infrastructure to administration officials.
"We would absolutely love to see the preservation of the exemption of muni bond interest," Brock said. "In addition, we would also like to see the state and local [tax] deductibility as well. We will continue to nurture this partnership."
Micah Green, a partner with Steptoe & Johnson in Washington, said he expects tax policy to be an early priority of the Trump administration.
"We've been talking about tax reform for ten years now," Green said. "Now there seems to be a much more directed and unified effort to get that done."
"I think that's driven by the realization that the current tax code is putting us at a competitive disadvantage," he added. "That's driving the sense that something needs to be fixed."
"Combine that with Trump's priority to provide tax relief as well as talking about some kind of infrastructure finance package," Green continued. "And you add that all up in a budget process beginning in the new year and that could lead to major tax legislation and potentially tax reform."
Congress could push forward with the first major tax bill passed since the Tax Reform Act of 1986, which significantly restricted the use of munis.
Trump's Tax Plan
Trump's plan would reduce the current seven individual income tax brackets to three with a 33% top rate, and would also reduce the corporate rate to 15% from 35%. Still, many muni advocates are waiting for a more detailed proposal to alleviate concerns that the muni exemption will still be on the table in a comprehensive reform package.
Giroux said Trump's expression of support for munis is significant because it is a recognition of the low-cost borrowing it provides state and local governments for infrastructure projects.
"We're seeing a public recognition of tax exemption goes hand-in-hand with the aggressive infrastructure plan we're hearing a lot about," she said.
Trump has proposed a 10-year, $1 trillion infrastructure plan that would use $137 billion of tax credits to generate $1 trillion of private investments. But some lawmakers on both sides of the aisle appear to have concerns about it, particularly its use of tax credits.
"If it is just viewed as pork barrel spending and purely economic stimulus, Republicans may have concerns about it," Green said. "If it is just viewed as privatization of infrastructure Democrats will have an issue with it."
Jim McIntire, president of the National Association of State Treasurers, said that while tax credits can be an attractive tool in some places, it is difficult to envision that all of the capital needed for a major infrastructure effort will be put up by the private sector.
"The public-private partnerships may actually deal with 10% to 15% of the infrastructure needs out there," McIntire said. "But most of it is going to have to be done with public tax revenues backing bond issuances of some kind."
"Typically in these circumstances you need to have some kind of revenue stream like tolls or other fees but a lot of our infrastructure needs are not going to be tollable," he added. "There's not something to charge a user fee on."
Trump's tapping of former Goldman Sachs president and chief operating officer Gary Cohen to become his top economic policy adviser is encouraging for munis, Green said, because his experience in fixed income includes a deep understanding of the bond market.
Until the plans are released in their entirety, Chuck Samuels, a partner at Mintz Levin, warns it is too early to speculate on their implications. However, he warned that House Speaker Paul Ryan, R-Wis., and House Ways and Means Committee Chairman Kevin Brady, R-Texas, may have different views than Trump.
"Brady and Ryan are not as enthusiastic about infrastructure improvements," Saumels said. "The congressional Republican view is let's improve the economy, let's do tax reform and then the funds will flow."
"The Trump view is more interventionist," he added. "Specific legislation and specific incentives."
Ed Oswald, a partner with Orrick, Herrington & Sutcliffe in Washington, said he sees the potential for a legislative proposal like the 28% cap on the value of munis proposed by President Obama in his last several budget requests. Local government groups like USCM say this cap could create hundreds of billions of dollars in additional costs for cities.
"I don't see the exemption being eliminated but being curtailed like the haircut that the Obama administration has proposed the past few years could be a possibility," Oswald said.
In a report released this month, PNC Financial Services projected a more bleak outlook for the state of the tax code's exclusion of municipal bond interest.
"It is very possible that the threat to the municipal bond tax exemption could rise during the Trump presidency and the 115th Congress," wrote PNC managing director and municipal strategist Tom Kozlik, author of the report.
"Add to that the negative attention the tax exemption expenditure has received from those who argue it is an inefficient incentive, and a stronger not weaker argument can be made for an increased threat," Kozlik added.
Opponents have argued that munis are an inefficient method of financing and can even encourage municipalities to over-invest in infrastructure.
A report released in June by the Tax Foundation argued that tax-exempt bonds are inefficient when comparing foregone federal government revenue and state and local borrowing costs, and can unfairly benefit higher income taxpayers.
The organization suggested considering what it identified as flaws of the muni exemption in potential tax reform legislation.
House GOP Blueprint
Many market participants have set their sights on the proposed House GOP blueprint for tax reform, which they believe raises more questions than answers regarding the future of munis.
The 35-page blueprint, released in June by Republicans under Ryan's "A Better Way" agenda, is expected to be drafted into formal legislation and introduced early in the new Congress. Brady has said that Republicans hope to introduce one or two tax reform bills in 2017, and lobbyists and market groups have speculated that legislation may already be drafted and ready for introduction within the first 100 days of the new Congress.
However, some lawmakers are supporting two bills, the first on corporate tax reform.
"The individuals we've been speaking with in D.C. are of the mindset that we are going to see corporate tax reform before individual tax reform, said John Vahey, managing director of federal policy for BDA. "Do we expect to see more details on the individual side within the first 100 days? It's doubtful."
Nevertheless BDA and GFOA will be ready.
"It wouldn't be a surprise to see the GOP blueprint within the first 100 days," Brock said. "The way it was discussed post-election, we should anticipate its arrival. We're prepared for it."
Like Trump's tax proposal, munis are not mentioned directly in the GOP plan. However, the blueprint proposes repealing unnamed special-interest provisions, which has caused a sense of uneasiness within the muni community.
"Nothing at this point is telling us that we're safe," said NACo's Belarmino. "We keep hearing that everything is on the table, including the muni exemption. We're going to stay vigilant and engage the House and the administration."
The blueprint would reduce the corporate income tax rate to 20% from 35%, and would also reduce the current seven-bracket individual income tax rate to three brackets with a top rate of 33%. It would also repeal the alternative minimum tax, a supplemental tax, for both corporations and individuals.
The AMT repeal could benefit certain private activity bonds (PABs) that are subject to that tax. The tax was initially intended to prevent high income individuals from using loopholes to avoid having to pay taxes, But it now effects many more taxpayers because of "bracket creep," where inflation pushes income into higher tax brackets.
Investors who buy PABs subject to the AMT typically pass less for the bonds and that raises the interest rates or borrowing costs for issuers.
Samuels said one provision of the blueprint arguably could imply some partial taxation of tax-exempt interest and would greatly advantage other individual income relative to tax-exempt interest. That provision would allow families and individuals to deduct 50% of their net capital gains, dividends and interest income.
However, Samuels said, "You can't really analyze individual pieces until you know what the whole proposal is." I'm not sure what the House proposal is going to say on tax-exempt interest."
Oswald agreed that elements of uncertainty make predictions for 2017 difficult.
"It's often the case that tax-exempt bonds are known by members of the House Ways and Means Committee and the Senate Finance Committee, but beyond that I find that there is some element of uncertainty with lawmakers with what to do with TEBs," Oswald said. "It will be a fight, but I think it's too early to forecast how things might turn out."
In the corner of the municipal securities community is the bipartisan municipal finance caucus headed by Reps. Dutch Ruppersberger, D-Md., and Randy Hultgren, R-Ill., though neither is on the House Ways and Means Committee. The caucus advocates for the maintaining of the muni exemption.
Giroux said the passage of bipartisan tax reform legislation is as likely as ever because the new administration, Republican lawmakers and top Democrats in Congress all want major tax reforms and more spending on infrastructure.
"We've got Republicans controlling the House, Senate and White House and Schumer on the Senate side who has a good working relationship with Trump and in the Senate," Giroux said. "I think you've got great leaders in good positions on both sides of the aisle. Sounds to me like a solid attempt to be as bipartisan as possible."
Giroux is staying upbeat about the coming year. "I think 2017 will be a hopeful year," she said. "There is a lot to get done and there needs to be a willingness to tackle big topics like tax reform. I think we have endless possibilities."
Online Sales Tax
State and local groups will be closely watching online sales tax legislation, which has been introduced in multiple forms but has seen little traction as they say municipalities continue to suffer the loss of the potential revenue from online sales.
Brock said promoting the destination-based approach to the collection of online sales tax is another of GFOA's top priorities next year. Funding infrastructure spending at the local level goes hand-in-hand with sales tax revenue, she said.
"We need to have resources to support that and we're in an environment where more and more retail purchases are made online," Brock said.
Brock said that when Rep. Bob Goodlatte, R-Va., released a draft Online Sales Simplification Act of 2016, GFOA saw that as a sign that the House Judiciary Committee chair was interested in talking about moving online sales tax legislation.
But Goodlatte's bill is extremely complicated and is based on "hybrid origin-sourcing." His draft would allow a state to tax internet sales if it is an origin state where the seller has a physical presence and the largest number of employees. The state would also be required to participate in a statutorily-created clearinghouse. The tax would use the origin states determination as to what is taxable and the destination state's sales tax rate.
Brock noted that Goodlatte's district includes Roanoke, Va., a city she said experienced a 4% sales tax revenue decrease in 2015. These municipalities are in need of the additional revenue that a destination-based approach to sales tax would provide, but she was not outwardly confident that such a bill providing that could move forward in the next year, she said.
"I can't say that we will see an online sales tax bill progress," Brock said. "But the Speaker is a friend of regular order and there is a lot of dependence on committee chairs to advance legislation. Perhaps some kind of advancement is possible."
Goodlatte's draft was well received by more than 100 businesses, which said it would help reduce regulatory hurdles to online, catalog and other remote sellers.
Belarmino said NACo is also hoping online sales tax legislation will advance in the next session of Congress, but said it is unclear where Trump stands on the issue. NACo has had discussions with lawmakers on both sides throughout the fall and will continue to going forward, he added.
"Those remote sellers, the online retails, they are still using local infrastructure and they benefit from that," Belarmino said. "The roads, the airports, you name it. They're using that local channel to get goods to the consumer."
The past year did not bring the progress that the group was hoping to see, he said, and the urgency to pass an online sales tax bill is even greater in 2017. Due to the standstill, five states have adopted their own remote seller tax laws.
"It's an uncertainty but I'm not sure we're lacking confidence in the coming year," he said.
State and local groups have championed the destination-based Marketplace Fairness Act sponsored by Sen. Mike Enzi, R-Wyo., and the Remote Transactions Parity Act sponsored by Rep. Jason Chaffetz, R-Utah.
Both bills would compel retailers to collect taxes on remote sales based on the location of the consumer. The state in which the consumer resides could compel out-of-state retailers to collect remote sales taxes, either as a member of the Streamlined Sales Tax Governing Board or through the use of certified software providers.
They would have to be reintroduced in the 115th Congress. Another pending bill, introduced by Rep. Jim Sensenbrenner, R-Wis., called the No Regulation Without Representation Act of 2016 (H.R. 5893) would require merchants to collect sales tax only if the person or company is physically present in that state during that tax period.
