House Minority Leader Nancy Pelosi’s proposal to extend the Bush-era tax cuts for households with incomes earning up to $1 million annually would have a marginal impact on municipal bond demand, market experts said.
The proposal, an attempt by the California Democrat to bridge a compromise between the two parties, has been put on the table as House Speaker John Boehner, R-Ohio., plans to bring up expiring tax provisions in July.
But the Center on Budget and Policy Priorities has found that the Pelosi proposal would lose as much as $366 billion over 10 years in revenue. That compares to the $829 billion in revenue gains that would be achieved if taxes increased for incomes of $250,000 and above, as the Obama administration has proposed. However, the administration has not ruled out increasing the threshold to the $1 million mark.
“This means that policymakers ultimately would need to find $366 billion more in deficit savings to offset the cost,” the CBPP said. “That would make key programs ranging from Medicare to Medicaid, and other low-income programs, to education, basic research, food safety, defense and homeland security significantly more vulnerable to deep cuts.”
Pelosi said she doesn’t agree with the CBPP’s calculations and instead emphasizes her middle-ground approach. “It’s a path to getting something done,” she said.
Chris Mier, a managing director of the analytical services division at Loop Capital Markets LLC, and Chris Mauro, director of municipal bond research at RBC Capital Markets, both pointed out how little marginal tax rates influence municipal bonds when compared to the 10-year Treasury rate over the last 30 years.
“There are enough factors that go into muni pricing that marginal tax rates are just one of them and by themselves are not that important,” Mier said “The marginal tax rate is one of many factors in determining municipal valuation.”
Still, Matt Fabian, managing director of Municipal Market Data, said generally allowing tax rates to rise is positive for the tax-exempt market because it makes munis relatively more attractive compared to other investments. Individuals earning more than $1 million would face a higher marginal tax rate and that would likely increase demand for municipal bonds.
“At the most, we may get some modest improvement because of a small increase in the attractiveness of munis on the margin for a select group of taxpayers,” Mauro said. “But this proposal doesn’t lead you to believe it will do much to move the needle on munis.”
In 2009, the latest year statistics were available, individual tax returns with adjusted gross income over $250,000 accounted for 44.8% of the aggregate tax-exempt interest income declared by individuals, according to Internal Revenue Service statistics. Returns with AGI over $1 million accounted for 21.9% of aggregate tax-exempt interest income.
Pelosi urged Boehner in a May 23 letter to bring a vote to the floor on a middle-income tax cut. “If we can get the $1 million-and-above people to pay their fair share, we can get a lot of money,” she said. “It’s a path to reducing the deficit while we get the wealthiest people to pay their fair share, and it is a path to take us to tax simplification, tax reform.”
Boehner rejected Pelosi’s plan, saying raising taxes would be a “big mistake.” Even though her proposal has drawn criticism, aides said she proposed it because she believes that everyone can agree that individuals making an income of $1 million and higher can afford to pay higher taxes. Despite the projected revenue loss, the proposal was intended to highlight that Republicans refuse to put revenue increases on the table, an aide said.
Market and tax experts said that the proposal is largely posturing and unlikely to move until after the November elections. “I don’t think it’s serious,” said Howard Gleckman, a resident fellow at the Tax Policy Center. “I don’t think such a proposal would actually pass. It looks better on a bumper sticker.”
Gleckman said in terms of good policy, this proposal goes in the wrong direction. “We ought to be thinking about raising taxes on a lot more people, not fewer people, if we are going to do fiscally responsible budgeting,” he said.
Mauro said despite the proposal’s intentions, it doesn’t appear to bridge the ideological gap between Democrats and Republicans. The GOP has pledged not to raise taxes and to maintain the current rates across the board, while Democrats still push for a millionaire’s tax.
Instead, there would have to be compromise, given the collective economic impact of all of the fiscal cliff issues, Mauro said. It’s unclear what the final tax package compromise will resemble, but lawmakers will reach back to the Simpson-Bowles proposal, which, among other things, suggested scaling back or eliminating tax expenditures and contained as an illustrative example a proposal to eliminate tax-exemption for new municipal bonds.