WASHINGTON – It may not be appropriate in corporate tax reform to disallow the tax exemption for municipal bonds purchased by corporations, since the exemption is designed to benefit state and local governments, according to a Congressional Research Service report.
The exemption for general obligation bonds, as well as the low income housing tax credit, “are technically affecting corporate taxes but are intended to flow benefits through largely to other recipients and thus may not be appropriate to consider for corporate rate reduction,” Jane Gravelle, CRS senior specialist in economic policy, wrote in a report on corporate- or business-only tax reform issues.
Also, if the tax exemption for GO bonds and the LIHTC were disallowed for corporations, “unincorporated businesses would likely increase their activities and offset much of the potential revenue gain,” Gravelle added.
Some corporations, such as banks and property and casualty insurance companies, hold municipal bonds as investments, said Michael Decker, a managing director at the Securities Industry and Financial Markets Association. When the Joint Committee on Taxation estimates the amount of revenue loss due to the tax exemption for different categories of bonds, it calculates the revenue loss attributable to corporations separately from the revenue loss attributable to individuals and non-corporate, pass-through businesses. Also, some corporations benefit from tax-exempt bonds as borrowers, Decker said.
CRS calculations based on JCT estimates found that the exemption for governmental tax-exempt bonds cost the federal government $9.2 billion on the corporate side in fiscal 2014, and $23.8 billion on the individual and pass-through side in that year. The exemption was the fifth largest corporate tax expenditure in fiscal 2014.
The tax exemption for qualified private-activity bonds was the 18th largest corporate tax expenditure in fiscal 2014, costing the federal government $1.8 billion. On the individual and pass-through side, the exemption for PABs cost the federal government $4.7 billion, according to the report.
Some tax proposals have focused on business-only tax reform. As part of such reform, tax expenditures could be disallowed for corporations to broaden the tax base and finance corporate rate reductions, CRS said.
But Gravelle considers the exemption for GO bonds and the LIHTC to be tax provisions “whose benefits flow through to other entities,” making it unwise to disallow for corporations. The tax-exemption for private-activity bonds might also be that type of corporate tax expenditure, she wrote.
The exemption for GO bonds is supposed to benefit municipalities by allowing them to borrow money at lower interest rates. The LIHTC is designed to lower housing costs for low-income tenants, according to the report. Owners of multifamily housing buildings can receive 4% LIHTCs if they finance at least half of the project with tax-exempt PABs.
“Private activity bonds allow reductions of interest on borrowing by private entities to finance assets used in certain types of activities, such as hospitals, mass transit facilities, wharves and docks, and other items,” Gravelle wrote. “Although corporations may capture some of the benefits, these provisions lower the cost of construction that may be viewed by some as desirable to subsidize. The revenue gain from disallowing the tax expenditure for corporations might also be largely offset as individuals replace corporations as bondholders.”
The comments about PABs in the recent report comes after Gravelle testified before the Senate Finance Committee in February that repealing the exemption for PABs would provide revenue to help pay for lowering corporate tax rates. Speaking personally and not on behalf of CRS, Gravelle told The Bond Buyer that eliminating the exemption for PABs is “a revenue option” but, that to be successful at raising revenue, it would have to be disallowed for both corporations and individuals.
Muni experts in Washington viewed the report’s comments about bonds favorably.
The “Congressional Research Service recognizes that the vast majority of the benefits related to the exemption for municipal bonds are shared by municipal issuers and individual middle-class investors and retirees,” said Jessica Giroux, general counsel and managing director of federal regulatory policy for the Bond Dealers of America. “If Congress intends to enact pro-growth corporate or individual tax reform it is paramount that the role that tax-exempt municipal bonds play in financing schools, highways, roads, and bridges is maintained.”
Decker also said that CRS “correctly” points out and emphasizes that while investors benefit from the exemption, “the principal beneficiaries of tax-exempt bonds are state and local governments.”
Chuck Samuels, a member of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, said, “The report is a well-balanced explanation of how actions that may seem superficially to be aimed at one policy goal end up rebounding and unintentionally affecting other policy goals. So, for example, trying to limit corporate purchases of tax exempt bonds may simply but inefficiently shift the market to other purchasers or even worse end up burdening the nonprofit or governmental sector to no overall public policy benefit.”
Bill Daly, director of governmental affairs for the National Association of Bond Lawyers, said it’s “refreshing” to see that CRS recognizes that the benefit of tax-exempt bonds are the users of facilities being financed with the securities. However, there’s still a risk “to some aspects of the tax treatment of bonds,” he said.
The comprehensive tax-reform proposal released last year by then-House Ways and Means Committee Chairman Dave Camp, R-Mich., would have eliminated the tax exemption for new PABs. Congress wouldn’t fully eliminate the PAB exemption in corporate-only tax reform, but it could eliminate the exemption for some types of PAB categories, Daly said.
