Consumption Tax Would Hurt Munis, Maryland County Official Tells Panel

A proposed bill to shift the tax collection system to a consumption-based tax instead of the current income-based system would harm the municipal bond market, Montgomery County, Md., finance director Timothy Firestine told President Bush’s tax reform panel this week.

Firestine — who is also debt committee chair on financial policies for the Government Finance Officers Association — said that a switch such as the one to a 23% national sales tax proposed by Rep. John Linder, R-Ga., would remove the tax advantage of tax-exempt bonds and increase state and local governments’ financial burdens.

Linder in January reintroduced legislation to repeal all federal income taxes, capital gains taxes, and gift and estate taxes. The congressman had introduced a similar measure in early 2004.

“If the federal income tax is eliminated and the exemption for municipal bonds is withdrawn, this would in effect force state and local governments to issue the equivalent of taxable bonds,” Firestine said in a presentation to the panel. “The costs associated with this change would be significant.”

He added, “If all investment income becomes tax-free, demand for tax-exempt bonds will decrease, causing an increase in debt issuance costs.”

With nearly $2 trillion in tax-exempt bonds currently outstanding, “the tax-exempt nature of the bonds makes them attractive in the marketplace and ensures a ready demand for these instruments,” Firestine said. “At a time when federal aid is decreasing and bond issuance is at an all time high in order to meet infrastructure and services needs for our citizens, the federal government should do everything possible to make the tax-exempt bond market efficient and avoid changes that would increase debt issuance costs.”

The panel’s simplification and reform efforts should focus instead on issues that would make the bond market work more efficiently, such as arbitrage rebate relief, bank deductibility, and raising the small-issuer exemption to $25 million from $10 million.

Bush appointed the bipartisan panel in January to reform the tax code. The panel is expected to submit recommendations on tax simplification and other reform measures to Treasury Secretary John W. Snow by July 31.