WASHINGTON – The municipal bond market may be hurt less by the final tax bill than initially expected, with the likely retention of private activity bonds, even if there are some restrictions on those bonds.

But the market will still be hurt by the loss of advance refundings and the huge reduction in the corporate tax rate to 21% from 35%.

The final bill, which is to be released Friday afternoon, is also expected to include a more flexible, if more stringent, federal deduction of state and local taxes. The bill will allow up to a deduction of up to $10,000 of state or local property taxes as well as income or sales, according to sources.

House and Senate conferees are expected to sign the final bill, which was negotiated by the Republicans with no input from Democrats, between 10 am and noon and then released sometime after that, House Ways and Means Committee chairman Kevin Brady, R-Texas, said Thursday.

House Ways and Means Committee Chairman Kevin Brady, R-Texas, chaired the Dec. 13 meeting of the House-Senate conference committee on tax reform in the U.S. Capitol.
House Ways and Means Committee Chairman Kevin Brady, R-Texas, chaired the Dec. 13 meeting of the House-Senate conference committee on tax reform in the U.S. Capitol. Bloomberg News

The preservation of PABs would be more in line with what the Senate wanted and is somewhat of a victory for the municipal bond market, given that the House bill had proposed to terminate them by Dec. 31. Still the final bill may not as good as the Senate bill, which would have retained them with no restrictions.

The final bill may eliminate the ability of muni issuers to carry-forward for up to three years any unused allocations of PABs. This would mean that they could not save up their allocations for big projects. Instead they would have to use or lose PABs in the year they were allocated. The bill also may eliminate small issue bonds used for manufacturing and may even reduce the volume cap for PABs.

Senate Majority Whip John Cornyn, R-Texas, told The Bond Buyer on Wednesday that he’s “optimistic” PABs will be retained in the final bill when it’s filed for public scrutiny at the end of the week. But he added, “I am not going to go through chapter and verse of the whole conference report."

The individual alternative minimum tax would be retained but would not apply to individuals with taxable income under $500,000 and families under $1 million. The AMT applies to PABs and makes them less attractive, thereby raising their yields. The corporate AMT would be repealed, as was included in the Senate bill.

Brady and other lawmakers are unhappy that PABs are used for projects involving corporations and other private parties, sources said. They claim there have been abuses. Brady has heard stories of PABs used to help finance a vineyard in California and felt that was a misuse of these bonds, the sources said.

But muni market participants claim that abuses – PABs used for massage parlors, golf courses, and McDonalds -- were shut down by the Tax Reform Act of 1986. The majority of PABs currently issued are 501(c)(3) bonds, which are used by nonprofit organizations such as hospitals and universities.

PABs are also a critical financing tool for multifamily and single-family housing and are used for airports, water and sewer projects, and local electric and gas facilities.

Ironically, Treasury Secretary Steven Mnuchin and other administration officials in past months had proposed expanding the use of PABs so they could be used along with public-private partnerships to finance infrastructure projects. The Treasury Department had put PABs on its priority guidance plan for 2017-2018.

Bonds are private activity bonds if more than 10% of the proceeds are used by a private party and more than 10% of the debt service is paid or secured by private parties. PABs are only tax-exempt if they fall within one of several “qualified” categories in the tax law.

Except for 501(c)(3), PABs are subject to state volume caps that are calculated each year based on a formula published by the Internal Revenue Service that uses annual U.S. Census Bureau population data and inflation estimates. The volume cap for each state in 2016 was the greater of $100 per capita or $302.875 million. The cap for 2017 is the greater of $100 per capita or $305.32 million.

A survey released by the Council of Development Finance Agencies in September that was based on PAB data for 2016 that was provided by the states showed that the total volume cap for states for that year was $35.14 billion.

The amount of unused PAB volume cap that was carried forward for three years, from 2012 through 2015, was $63.90 billion. And the amount of unused cap being carried forward into 2017 was $62.44 billion. The amount of unused volume cap that was abandoned in 2016 was $9.57 billion.

CDFA’s annual surveys can be used as rough guides to gauge trends but are somewhat flawed, by the group’s own admission, because every year some states fail to provide PAB information.

Barbara Thompson, executive director of the National Council of State Housing Agencies, said that if carry-fowards of PABs are eliminated that would "be a major change that will hit deeply into housing resources.”

She said it would not be a small change because it would hamper the ability of states to reallocate their PAB volume when a particular project falls through. Multifamily housing is often the beneficiary of those reallocations, she said

The termination of tax-exempt advance refundings by year-end is not a surprise because both bills had proposed that. This will eliminate the flexibility that muni issuers have had to take advantage of lower interest rates and free up funds for other projects. It will raise costs for issuers.

Ben Watkins, Florida’s bond finance director said recently that his state saved $3 billion over the past 10 years by being able to advance refund its bonds,

Muni market groups, particularly issuer groups, have been pushing lawmakers for transition rules that would delay the effective date by six months to a year. Sources have not heard whether this relief will be provided in the final tax bill.

Some tax experts say the tax bill has been so rushed, it will contain a lot of mistakes, raising the prospect of a technical corrections legislation will be needed.

Sources are also unclear on whether the final tax bill will terminate tax credit bonds by Dec. 31 or ban the use of tax-exempt bonds for professional sports stadiums and arenas by Nov. 2 – provisions that were in the House bill.

One of the Senate's leading proponents of eliminating the federal tax exemption for financing professional sports stadiums says he's willing to agree to a future termination date.

"I'd be okay with that," Sen. James Lankford, R-Okla., told The Bond Buyer. That could mean pending projects such as the Clark County, Nev. plan for a Las Vegas National Football League stadium might be able to be grandfathered.

“There are lots of ways to be able do that, whether you are grandfathering folks in or whether you do what’s called a sunrise where you look at several years,” Lankford said. “There are municipalities that are in the process of trying to determine are we going to use that bond, are we not going to use it. Allow those people that are process to be able to use it but know that it ends at a date certain.”

Lankford introduced bipartisan legislation in June with Sen. Cory Booker, D-N.J., to end the tax exemption for professional sports stadiums that mirrors a House bill introduced in March by Rep. Steve Russell, R-Okla.

The final SALT provision is a nod to states with high income taxes like California as well as those with high sales taxes. The House bill had allowed for a deduction of up to $10,000 of property taxes. But Brady had promised California Republicans he would give them some relief from that provision. The deduction would have been eliminated altogether under the Senate bill. The final bill would allow the deduction of state and local property taxes, as well as income or sales taxes up to $10,000.

The final tax bill will slash the corporate rate to 21% from 35%, instead of 20% as was proposed in both the House and Senate bills. That will hurt municipal bonds because they become unattractive as an investment to banks, property and casualty insurance companies and life insurance companies. Banks may no longer want to do direct purchases or private placements of munis.

The top individual tax rate is expected to be set at 37%, now from the 39.6% rate in the House bill and from the 38.5% rate in the Senate bill. Brady said this would help offset the loss of state and local tax deductions for high income households.

The mortgage interest deduction would be capped at $750,000, up from $500,000 in the House bill but less than $1 million in the Senate bill.

Brady declined to discuss whether the final bill would include provisions to provide tax relief for Puerto Rico.

A newspaper in Puerto Rico, El Vocero, reported Thursday that the president of the minority Popular Democratic Party, Héctor Ferrer Ríos, said Republicans were considering a 5% tax rate for controlled foreign corporations that have established their operation center in Puerto Rico.

“We want to do more to help Puerto Rico rebuild so we have a number of ideas we’re looking at,” Brady said.

The House and Senate are expected to vote on the final tax bill early next week. Republicans want to send the final bill to President Trump before they break for the holidays and the end of the session.

They have controlled the tax bill. On Wednesday House and Senate conferees met on the tax bill and bitter partisanship erupted. The Democrats were angry that they had not been consulted as conferees and will have no opportunity to vote on the final bill produced by the Republicans until it reaches the floor of each chamber.

Republicans insisted the tax bill will provide economic growth, create jobs, and cut taxes, while Democrats complained the bill is a give-away to corporations, will mostly benefit the wealthy, and will hurt the middle class. They also faulted the bill for increasing the federal deficit.

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