WASHINGTON - The municipal bond market and state and local governments could benefit more from the election of Democratic Sen. Barack Obama as president than his Republican opponent, Sen. John McCain, according to an analysis of their tax, economic recovery and other proposals, as well as interviews with market participants and economists.
However, many of those interviewed expressed a great deal of skepticism about whether either candidate would be able to carry out his policies and proposals, given the current financial crisis.
The steps taken by the federal government to combat the crisis are already sending the federal deficit upward and any decisions about further spending will come as spending for Social Security, Medicare, and Medicaid are also projected to increase significantly.
"I think a couple of things are going to be restrictive on what either candidate does," said Craig Elder, a fixed-income analyst at Robert W. Baird & Co. in Milwaukee. "What you want to do and what you can do are two different things sometimes."
Much of the focus of market participants has been on the candidates' tax policies.
Obama's tax proposals could make municipal bonds more attractive to investors, especially those in the upper income tax bracket who would be facing a tax increase, Elder said.
"Higher tax rates make municipal bonds more appealing on an after-tax basis," he said. "Obama's tax plan would make munis more attractive simply because of after-tax yield."
The reductions in the marginal income tax rates that Congress enacted in 2001 and 2003 at the urging of President Bush are at the heart of the candidates' tax proposals. The cuts in the tax rates are scheduled to expire after 2010. The 10% income tax bracket would disappear and the 25%, 28%, 33%, and 35% brackets would rise to 28%, 31%, 36%, and 39.6%.
Obama would extend the 10%, 15%, 25%, and 28% tax rates but immediately restore the 36% and 39.6% rates for the highest income taxpayers - and adjust them so that they apply to individuals with incomes of more than $200,000 and married couples with incomes of more than $250,000.
The Illinois Democrat also would increase the maximum rate on capital gains for families making more than $250,000 to 20%, raise the top tax rate on qualified dividends to 20% from 15%, still keeping it below the pre-2001 level; and enact new and expanded tax breaks for workers, retirees, homeowners, savers, parents, students, and new farmers, according to the nonpartisan Tax Policy Center.
McCain would permanently extend the 2001 and 2003 tax rate cuts, increase deductions for taxpayers supporting dependents, reduce the corporate income tax rate, and allow immediate deductions for investments in certain capital equipment.
Both candidates would extend and index the "patch" for the alternative minimum tax to prevent additional moderate income taxpayers from having the tax apply to them. McCain proposes a permanent extension of the patch and would increase the exemption from the AMT by another 5% per year after 2013, according to the Tax Policy Center. The Arizona Republican has also talked about, but not formally proposed, eliminating the AMT for individuals.
The AMT applies to interest earned on private-activity bonds and some governmental and 501(c)(3) bonds and results in higher yields on such bonds. It took effect in 1970 to prevent high-income households eligible for several tax breaks from paying little or no taxes. However, the AMT is not indexed to inflation, so more taxpayers become subject to it each year.
A repeal of the AMT would increase the value of the private-activity bonds and 501(c)(3) bonds that had been subject to it, according to market participants. But this would not affect housing bonds, which were permanently exempted from the AMT in the American Housing and Economic Recovery Act, which Bush signed into law on July 30.
TAX RATES V. MUNIS
Under Obama's tax plan, the top 1% of wage-earners would face a $19,000 average tax increase, or a 1.5% reduction in after-tax income, by 2012, according to the Tax Policy Center. McCain's plan would cut taxes for those same wage-earners by more than $125,000, raising their after-tax income an average of 9.5%.
"Tax rates are one of the single most important determinants of relative value for munis," said Evan Rourke, vice president and portfolio manager at MD Sass Investors Services Inc. in New York. When the Bush tax cuts went into effect, Rourke said muni investors lost 10 to 20 basis points in relative value. Investors could see that value return if the Bush tax cuts are not extended, he said.
Richard Ciccarone, managing director and chief research officer of McDonnell Investment Management LLC, said long-term muni bonds are currently yielding about 6%. If the tax rate for the highest tax bracket rose to 39%, the taxable equivalent yield on that same long bond would be about 8%. A 5% yield for an investor in the 40% tax bracket is equivalent to an 8% return on a double-A, 15-year bond, he said.
"That would be a time for joy given the current market," Ciccarone said.
Of the two sets of presidential and vice presidential candidates and their spouses, only McCain's wife, Cindy, holds tax-exempt bonds. Her tax return for 2006, recently released by the campaign, reports $19,284 in tax-exempt interest earnings and $4.2 million of adjusted gross income for the year.
But Ciccarone argued that higher taxes are not good for job creation. "It would seem to be a deterrent to economic growth," he said.
"It is a positive if taxes go up [and] the bonds that you own will give you a better income," said Matt Fabian, managing director of Municipal Market Advisors in Concord, Mass. "But don't expect some big performance bump out of the muni sector any time soon. Expecting performance out of municipals right now is extremely difficult."
Muni bond prices have fallen this year as most of the major monoline bond insurers have lost their triple-A credit ratings.
Market participants also caution that it will be difficult for either candidate to follow through with their proposals given the current financial crisis.
"We have handicapped [Obama's] ability to put forth these promises," said Michael Pietronico, chief executive officer of Miller Tabak Asset Management in New York. There is "not a high rate of chance" Obama's campaign pledges can enacted into law, he said.
If the economy does not show signs of strength by Inauguration Day, the muni market might tilt toward favoring credit security over higher bond prices and lose interest in Obama's tax policies.
"If I had to say what is more important to the muni market right now, higher tax rates or a more stable credit environment, I would say a more stable credit environment only because the 50% of the market that was insured by these monoline insurers is now borrowing at substantially higher rates," Pietronico said. "So there is a credit crunch within the muni market and higher borrowing rates for your marginal issuers, and that is more of an immediate concern for credit quality."
Further, the Tax Policy Center estimates Obama's non-health-care related tax plan would cut taxes by a total of about $2.9 trillion between 2009 and 2018, while McCain's would reduce taxes by nearly $4.2 trillion over the same period. Without substantial cuts in spending, both plans would sharply increase the national debt, according to the center. Including interest costs, Obama's tax plan would boost the debt by $3.5 trillion by 2018 and McCain's plan would increase the debt by $5 trillion, the center said.
STATES & LOCAL GOVERNMENTS
Earlier this month, the candidates each unveiled economic recovery proposals.
Obama's economic recovery plan urges the federal government to create liquidity programs for state and local governments having trouble accessing the tax-exempt debt market. McCain's plan emphasizes tax cuts and a federal program to purchase mortgages directly from homeowners and mortgage services. McCain's only mentions federal government partnerships with state and local governments in the area of homeland security.
Obama called for the Federal Reserve and Treasury Department to jointly create a facility to act as a funding backstop for the state and local government debt market, similar to the Fed's commercial paper program for corporations.
"For all those cities and small towns that are facing the choice between cutting services like health care and education or raising property taxes, we'll provide the funding to prevent those tax hikes from happening," Obama said during a campaign stop in Ohio.
State and local groups have been pushing for federal assistance, but to no avail thus far, except for the Treasury's addition of tax-exempt money market funds to its temporary insurance program for such funds.
McCain offered a $52.5 billion proposal emphasizing tax cuts and government-sponsored mortgage and savings provisions. He would direct the Treasury to implement a program to purchase mortgages directly from homeowners and mortgage servicers and instead provide those homeowners with 30-year mortgages at interest rates reflecting the current market value of the home. The mortgage program would cost about $300 billion.
As a senator, Obama co-sponsored legislation introduced by Senate Banking Committee chairman Christopher Dodd, D-Conn., to create an infrastructure financing bank that would provide $60 billion over 10 years to finance highways and other projects in conjunction with municipal bonds. He also has called for full funding for the Community Development Block Grant program, which provides grants to state and local governments to fund economic development projects and can be used in projects financed by municipal bonds.
McCain's 25-year legislative career does not include a long track record of muni bond-related legislation. He sponsored a bill earlier this year that would have created a summer-long "holiday" from the gas tax, as a way to temporarily relieve consumers from higher gas prices, but that proposal drew wide criticism.
The bipartisan National League of Cities, which does not endorse either candidate, contends the federal government should "resist proposals that limit local authority or put local resources at risk." The group also says that federal policies should not mandate new costs for local governments without providing adequate funds to support local governments for these new mandates.
The NLC argues that instead federal programs should support "regional solutions" and encourage collaboration among federal, state, and local officials, as well as business and nonprofit organizations, to tailor policies to local needs and demands.
Obama seems to embrace a more interconnected federal-local government relationship, according to his proposals. He has said he plans a new White House Office on Urban Policy, which would "develop a strategy for metropolitan America and to ensure that all federal dollars targeted to urban areas are effectively spent on the highest-impact programs." However, the NLC points out that Obama does not provide specifics on this plan.
McCain has provided limited details of his plans for partnership with local governments on his campaign Web site. He discusses partnerships briefly in relation to first responders and homeland security, the NLC said.
The candidates differ substantially on their expectations for transportation and infrastructure, based on their statements, legislative records, and position papers.
The NLC points out that local governments own 75% of the four-million-mile highway and road network, 90% of transit systems, and nearly half of the nation's 600,000 bridges, and argues for opening up federal coffers to help local governments finance their infrastructure needs.
"A strong federal role in infrastructure financing and planning, as well as an effective intergovernmental partnership with local governments, is necessary if we are to meet our nation's infrastructure needs and provide for quality and sustainable economic growth," according to the NLC's policy positions on its Web site.
Obama's campaign has proposed more transportation initiatives, "but that doesn't mean he's talking about issues that have more likelihood of being passed or more likely to have support from our members," said Jeff Solsby of the American Road and Transportation Builders Association, which does not endorse presidential candidates.
The federal highway trust fund, comprised almost entirely of gasoline tax revenue, the major federal funding source for highway projects, is expected to be short $3 billion to $6 billion by the end of fiscal 2009. McCain's record shows some opposition to the current formula for highway infrastructure funding.
In 2007, he blamed the current funding system for ignoring deficient bridges and "funding a significantly higher level of bike paths and highway beautification projects and sidewalk improvements." McCain said he would rather re-prioritize transportation spending than raise gas taxes to support an ailing highway trust fund.
Obama in August proposed an emergency economic plan that would provide $25 billion, in part to help the highway trust fund. He does not support raising the federal gas tax.
The American Association of State Highway and Transportation Officials is looking to both candidates for answers, not just on immediate funding, but also on Washington's traditional way of raising revenue for roads.
"As we enter a period where we're going to authorize surface transportation programs for the future, what should be the federal government's role?" asked Jack Basso, AASHTO's director of management and business development.
Though he was formerly chairman of the Senate Commerce Committee's aviation subcommittee, McCain appeared to primarily focus on safety issues. In recent months, airports in both candidates' states have received federal money. Arizona airports received about $5.4 million in annual subsidies through the Essential Air Service program as of August. Illinois airports got about $4 million. The Yuma, Ariz., airport received $200,000 from the Small Community Air Service Development Program in 2007. No Illinois airports were included in that program last year according to records.
Obama and McCain differ on their housing initiatives, though lobbyists said neither has offered anything concrete to help state and local housing finance agencies.
"I don't think they've been all that specific," said John Murphy, executive director of the National Association of Local Housing Finance Agencies, adding that he "didn't look to either of them to play a leadership role" in crafting housing legislation.
McCain's approach to help subprime and other financially strapped mortgage borrowers falls under his American Homeownership Resurgence Plan. It would allow holders of mortgages that are larger than the current value of the home and taken out after 2005, and who live in their home, to "trade" a burdensome mortgage for an FHA-guaranteed fixed-rate mortgage that reflects their home's market value.
Obama would create an affordable housing trust fund, fully fund the CDBG program, create a 10% universal mortgage tax credit for homeowners who do not itemize their deductions, and allow bankruptcy courts to modify an individual's mortgage payments.