MINNEAPOLIS — Now is the time for state and local finance officers to advocate for preserving the tax-exemption for municipal bonds, even though federal tax reform is highly unlikely to happen this year, market group officials said at the Government Finance Officers Association's annual conference here.
"Congress is back home in the district[s] a lot, and many of them are also running for reelection right now, so it's a great time to catch up with them," said Dustin McDonald, director of GFOA's federal liaison center.
Government finance officers should also get their local elected officials involved in efforts to preserve the muni exemption, said Michael Decker, managing director and co-head of municipal securities for the Securities Industry and Financial Markets Association.
President Obama has repeatedly proposed capping the value of the muni exemption at 28% in his budgets. The tax-reform proposal by House Ways and Means Committee chairman Rep. Dave Camp, R-Mich., includes effectively capping the value of the exemption at 25% by imposing a 10% surtax on muni interest for high earners.
Tax reform is not expected to happen this year because it is an election year and there is a lot of congressional gridlock. Camp is term-limited in his role as Ways and Means Committee chairman and is not seeking reelection to the House, the experts said.
But while the heat may be off in the short run, muni curbs could come up again in the future. Rep. Paul Ryan, R-Wis., is likely to become House Ways and Means Committee chairman in 2015, and he, like Camp, will be interested in tax reform that closes tax loopholes and reduces the top marginal tax rates. In order to achieve those goals, tax provisions of importance to state and local governments could be on the table, McDonald said.
Decker said that if he were Ryan, he would be looking at "who's complaining the loudest about what provisions of [Camp's] proposal." The reactions could color how Ryan drafts his own tax-reform proposal.
GFOA's advocacy efforts in response to Camp's plan have focused on criticizing three aspects of the proposal: the surtax, the elimination of the deduction for state and local taxes, and the elimination of the tax-exemption for advance refunding bonds issued after 2014, McDonald said.
GFOA is part of the "Don't Mess With Our Bonds" coalition, which has recently prepared two letters, one to the White House about the problems with the 28% cap, and the other to Ways and Means leadership about the surtax, he said.
Decker pointed out two other aspects of Camp's plan that would be harmful: the elimination of bank-qualified bonds and the ability to issue tax-exempt private-activity bonds.
If the muni curbs were enacted, investors' would demand higher yields and issuers' borrowing costs would increase. As a result, state and local governments would be the ones burdened by a tax on muni bond interest, Decker said.
Both Obama's 28% cap and Camp's surtax would be retroactive: applying to both new and outstanding bonds. If Congress imposed a tax on outstanding bonds, investors would wonder if this tax would be raised later. As a result, a risk premium could be priced into the market associated with the fact that Congress could impose an additional retroactive tax on outstanding bonds in the future, Decker said.
Senate Finance Committee chairman Sen. Ron Wyden, D-Ore., is focusing on issues besides tax reform in the short-term. But in the past, he has sponsored bills that would halt the issuance of tax-exempt bonds in favor of traditional tax-credit bonds that provide investors with tax credits equaling 25% of the interest costs.
When Wyden has been asked about tax-credit bonds in the past, he's pointed to the success of the Build America Bond program. But McDonald pointed out that state and local governments didn't issue any BABs as traditional tax-credit bonds, even though they had the option to do so, because there's not much of a market for those types of bonds. Instead, the roughly $182 billion of BABs were issued as direct-pay bonds. Decker said Congress keeps coming back to the idea of tax-credit bonds despite market groups pointing out their weaknesses because many Republicans are opposed to direct-pay bonds since they provide direct subsidies to state and local governments.
While direct-pay BABs were popular when they could be issued in 2009 and 2010, the market is more skeptical of them now because the subsidy payments have been subject to federal spending cuts known as sequestration. Congress passed a budget agreement in December that lifted the sequester for some programs, but the bill actually extended sequestration for BAB subsidies by two years, through fiscal 2023. Then in February, Congress passed other legislation that extends sequestration for the subsidies through fiscal 2024.
Decker and McDonald both said that sequestration has eroded issuers' confidence in programs like BABs and would discourage issuers from taking advantage of BABs or a similar program in the future. SIFMA will continue to tell the Obama administration, which has proposed a similar program to BABs in its fiscal 2015 budget, that the promised subsidy level needs to be maintained, Decker said.
