WASHINGTON - Curbs to the tax exemption for municipal bonds would increase electricity prices for public-power customers and make it less likely that infrastructure improvements would be funded, groups warned in a paper to Senate Finance Committee tax-reform working groups.
Munis are "the single most important financing tool for public power, given the capital-intensive and long-lived nature of assets needed by the electric industry," the American Public Power Association, the Large Public Power Council and the Transmission Access Policy Study Group said in a paper submitted to two of the working groups last week.
The working groups are charged with making recommendations by the end of May, and their efforts are designed to contribute to a tax-reform bill to be introduced in the Senate Finance Committee later this year.
Power-related munis make up about 5% of muni issuances each year, according to data from The Bond Buyer and Thomson Reuters yearbooks cited by the groups. Significant additional capital investment in the electric sector will likely be needed in the near term because of changes in the area.
Investors purchase munis in part because of their tax exemption, but also because they are stable, have a low risk of defaulting and generate a steady stream of revenue for fixed-income households. Also, "there is a longstanding and comprehensive federal legislative and regulatory system in place to regulate the tax-exempt bond market," the groups said.
If Congress taxed muni interest, the costs would be borne by state and local residents, not investors, the groups said.
"An outright repeal of the exclusion for municipal bond interest would both undermine a century of tax-policy precedent and devastate the ability of state and local governments of all sizes to seek financing in an effective, well-regulated, well-understood, and stable market," the groups said.
A cap on the tax value of the muni exemption would not just affect high earners. "All potential investors would demand an interest rate premium on new issuances, either as compensation for the loss of net earnings or to offset the downward pressure on secondary market value caused by the new tax," the groups said. "An additional risk premium would be demanded by the market to compensate for possible future federal tax rate increases, as well as for future downward reductions in the cap rate."
A flat-dollar cap on the amount of deductions and exclusions a taxpayer could claim would essentially be a repeal of the muni exemption. That's because taxpayers would fill the cap with other expenses, such as health care and retirement expenses, the groups said.
While there are several alternative debt instruments that are supplements to tax-exempt bonds, each of these tools have "substantial inefficiencies," and none of them individually would be a viable replacement for munis, the groups said.
Taxable bonds could not replace munis without state and local governments having dramatically higher borrowing costs. Also, the taxable market generally only accommodates large bond issues, and provisions that allow for optional bond calls prior to final maturity are rare and costly in taxable bonds, according to the letter.
With direct-pay bonds, issuers have concerns about cuts in subsidy payments either because they owe the federal government money under other programs or because of sequestration. Demand for traditional tax-credit bonds has been limited. And restrictions on qualified private-activity bonds cause them to be rarely used by government-owned utilities to finance energy infrastructure improvements, according to the letter.
In addition to wanting to see the muni exemption preserved, the public-power groups also would like to see improvements to muni rules. The groups support proposals in President Obama's budget to repeal the 5% unrelated or disproportionate private business use test and to simplify arbitrage investment restrictions. They would also like some private business use and payment limitations to be repealed.
