Municipal bonds are key to reaching the infrastructure goals laid out in President Obama’s State of the Union Address, but curbs on tax exemption could make it difficult to fund the large-scale projects he described, market participants said Wednesday.

“I was glad to see talk in the State of the Union about the need to do something about infrastructure,” said Bill Daly, director of governmental affairs at the National Association of Bond Lawyers. “Balanced against that, I am concerned about [tax reform] and I expect it will include the cap ... on tax exempt interest.”

“Since most of the infrastructure in the country is focused on tax-exempt bonds, [a cap] goes against the emphasis on infrastructure,” he said.

“There is no way of talking about [infrastructure] without talking about tax-exempt bonds,” said Susan Collet, senior vice president of government relations at Bond Dealers of America.

But Collet warned, “As long as revenues are on the table, whether to patch the sequester or to overcome an eventual replay of the debt ceiling debate, we have to be very vigilant.”

In his address Tuesday, which focused largely on job growth, promoting middle-class prosperity and tax reform, Obama announced a $50 billion “Fix-it First” program that would put Americans to work on infrastructure improvement projects. He said there are some 70,000 deficient bridges in America.

He also proposed a “Partnership to Rebuild America” program to attract private money for ports, pipelines and schools.

Obama said the government’s $4 trillion deficit-reduction goal could be reached with spending cuts and revenue gains, and that hundreds of billions of dollars could be saved “by getting rid of tax loopholes and deductions for the well-off and the well-connected.”

Market participants fear lawmakers may impose a 28% cap on the value of tax-exempt interest for wealthy taxpayers, which was in Obama’s 2013 budget proposals and earlier draft jobs legislation. The cap could raise issuers’ borrowing rates by 65 to 70 basis points and cut infrastructure investment and job growth, muni groups have said.

Municipal Bonds for America, a coalition formed last year to advocate for munis, issued a statement Wednesday encouraging “the administration and Congress to work cooperatively to preserve the tax-exempt status.”

“Municipal bonds finance schools, airports, bridges, health care facilities, affordable housing, and other vital infrastructure needs that touch our daily lives,” said MBFA, whose members include BDA, dealers, issuers and others. “Without access to tax-exempt municipal bonds, public infrastructure costs will increase significantly. Much of that increase would be paid for by every taxpayer through increased taxes and fees.”

Dustin McDonald, director of the Government Finance Officers Association’s federal liaison center, said, “We are encouraged by the president’s focus on improving the national economy, especially through infrastructure investment.”

But he warned the President’s proposals should not impose additional economic burdens on muni issuers. “Such reforms must not move forward on the backs of local and state governments,” he said. 

Mention of infrastructure is positive for the market, said Michael Decker, co-head of municipal securities at the Securities Industry and Financial Markets Association. But the president’s speech highlighted muni market threats from tax reform, the sequester, the debt ceiling and expiration of the continuing resolution he noted.

“Sooner or later the federal government will have to come up with a fiscal reform initiative that will shrink the deficit,” Decker said. “If revenue is on the table, then the municipal market faces a risk that there could be a curtailment of the tax exemption.”

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