WASHINGTON — President Obama’s $3.8 trillion fiscal 2013 budget alarmed the muni market by proposing to reduce the value of tax-exempt interest and other tax preferences to 28%. But he cheered market participants by proposing to resurrect and expand the popular Build America Bond program and ease several tax requirements.

However, there is virtually no chance the budget plan will move forward due to fierce Republican opposition and congressional gridlock, tax experts and market experts agreed.

“This entire budget is essentially dead before arrival,” said Ken Kies, managing director of the Federal Policy Group and former chief of staff on the congressional Joint Committee on Taxation.

Republicans were quick to denounce the budget plan. House Budget Committee chairman Rep. Paul Ryan, R-Wis., called it “irresponsible” and a “recipe for a debt crisis and the decline of America.”

The 28% cap proposal, which had been expected, is the same the president proposed last fall in his jobs bill. That bill failed to gain any traction in Congress. It would apply to single taxpayers with income over $200,000 and to married taxpayers filing a joint return with income over $250,000. The administration projects the 28% cap, which would take effect for taxable years beginning after Dec. 31, 2012, would reduce the federal deficit by $584 billion over 10 years.

Market participants warned the proposed cap would hurt the muni market, increasing borrowing costs for state and local governments and eroding the value of bonds in investors’ portfolios.

“It still baffles me how the administration can, on the one hand, invest in infrastructure and then impose a tax on the way most of the infrastructure is financed,” said Bill Daly, a senior vice president at Bond Dealers of America.

Michael Decker, co-head of the muni division at SIFMA, said: “In general, I think the administration recognizes the role infrastructure should play in the economic recovery. At the same time, they are proposing to cripple what is arguably the most important program the federal government has for providing aid for infrastructure, and that is tax-exempt interest on state and local bonds.”

Susan Gaffney, director of the Government Finance Officers Association’s federal liaison center, said the 28% cap is likely to come up in tax-reform discussions on Capitol Hill because Obama has proposed it twice.

The president proposed allowing the Bush-era income tax rate cuts to expire, but urged Congress to “undertake comprehensive tax reform to cut rates, cut inefficient tax breaks, cut the deficit, and increase jobs and growth,” while observing the “Buffett Rule” that people making over $1 million not pay lower taxes than the middle class.

The BAB proposal mirrors the ones Obama proposed for fiscal 2012 and fiscal 2011, with the exception of the subsidy rate. The BAB program was established under the American Recovery and Reinvestment Act but expired at the end of 2010. BABs are taxable, but the Treasury Department pays issuers a subsidy rate equal to 35% of their interest costs.

For fiscal 2012 and 2011, the administration proposed lowering the subsidy rate to 28%, which it said would be a “revenue- neutral rate.” For fiscal 2013, the president is proposing a 30% subsidy rate for two years and a 28% rate thereafter.

Like the earlier proposals, BABs could be used for certain current refundings, governmental cash-flow financings subject to a 13-month maturity limit, and financings for 501(c)(3) nonprofit entities such as hospitals and universities.

“We are certainly all for providing more tools in the toolkit for state and local governments,” said Lars Etzkorn, program director for federal relations for the National League of Cities.

The budget proposal would also ease tax-law restrictions, such as allowing current refundings of state and local governmental bonds that satisfy size and maturity limits. The issue price of the current refunding bonds could be no greater than the outstanding principal amount of the refunded bonds. The weighted average maturity of the current refunding bonds could not be longer than the remaining weighted average maturity of the refunded bonds.

The budget proposal would simplify arbitrage investments restrictions and streamline private business limits on governmental bonds. The small-issuer exemption from the arbitrage rebate requirement would be increased to $10 million from $5 million and would be indexed for inflation. The proposal also would remove the general taxing power constraint on small-issuer eligibility.

Decker said these proposals are encouraging because current arbitrage rules are “needlessly complex and impose high compliance costs and burdens on issuers.”

The administration also would adopt the Treasury’s recommendations to ease restrictions on tribal government tax-exempt financings and essentially put them on par with states and localities. The “essential governmental function” restriction would be repealed and tribal governments could issue tax-exempt private-activity bonds for the same purposes as states and localities under a tailored national volume cap.

The budget calls for a $200 million annual tax credit from 2013 to 2022 to provide transportation upgrades to New York’s World Trade Center rebuilding.

Additionally, $2 billion would be provided for clean water and drinking water state revolving funds.

Obama has proposed a six-year, $476 billion reauthorization of highway and transit programs, a sharp contrast to the five-year, $260 billion proposal pending in the House and the two-year, $109 billion bill pending in the Senate.

The proposal would be paid for with a “peace dividend” derived from savings that would have been spent on the war in Iraq, which ended last year. The House and Senate have been able to bridge much smaller funding gaps only through the use of contentious proposals, such as House Republicans’ idea to leverage revenue from leases on new and expanded domestic oil-drilling programs. Mica and other Republicans have been skeptical of what they see as an attempt to fund infrastructure by “downsizing” the military.

The budget also would grant more than $1 billion per year for the Transportation Infrastructure Finance and Innovation Act program, increasing it to nearly $2 billion for fiscal 2013. House Transportation Committee Chairman John Mica, R-Fla., has said an increase in funding for TIFIA would eliminate the need for a national infrastructure bank, provide loans that can be used to back munis and promote private investment. However, Obama is proposing the creation of such a bank.

High-speed rail and other passenger rail programs would receive $47 billion in federal money over six years under the budget proposal, even though high-speed rail projects have come under increased scrutiny in recent months as some of the mostly bond-financed proposals have suffered from inaccurate feasibility studies and ballooning costs. The transportation bill pending in the House would ban high-speed rail funding for California projects.

Airport advocates were unhappy with the budget, which includes a cut of over $900 million in grants to larger airports in favor of distributing more funding to smaller airports.

Brad Van Dam, vice president of federal affairs at the American Association of Airport Executives, said the administration wants to offset this cut by raising the cap on passenger facility charges. Those charges, which airports collect and use to back bonds, are currently capped at $4.50 per passenger. Nowhere in the budget, though, does the president provide for the fee increase, he said. Van Dam said the proposal is the same as last year’s, but even more head-scratching because the four-year Federal Aviation Administration reauthorization bill approved by Congress Feb. 6 did not include a PFC increase.

“The likelihood that Congress will turn around and raise the PFC cap is not very likely,” Van Dam said. “From our perspective, it’s more of the same.”

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.