Muni market 'cautiously optimistic' after GOP tax bill leaves tax exemption untouched

TONYVALADEZ.COM

Municipal market participants Monday cheered the survival of their prized tax exemption in the first draft of a sweeping House tax bill but weren't quite ready to pop the Champagne.

The release of the Ways and Means Committee tax bill Monday kicks off complex and high-stakes negotiations during which the muni market could find itself again in the crosshairs.

"I'm cautiously optimistic, but there's still probably months to go and there are some really big numbers and major policies being talked about," said Tom Kozlik, head of public policy and municipal strategy at HilltopSecurities.

"Maybe lawmakers are listening to the Public Finance Network's advocacy and education, so that's good," Kozlik said. "But I would also stress that the negotiations for this tax policy are going to be very fluid."

The muni market has been worried for months that Congress would eliminate or chip away at tax-exempt municipal bonds, specific sectors or private activity bonds to help cover the cost of the GOP's "one big beautiful bill," which carries a price tag of at least $5 trillion.

The legislation is likely to change as House leaders navigate it through their tight three-vote majority. A major sticking point over the state and local tax deduction cap has yet to be ironed out. Ways and Means will mark up the bill Tuesday afternoon in what's expected to be a marathon session.

"It's a great start," said Emily Brock, federal liaison at the Government Finance Officers Association. "But the process has only just begun. I'd like to see the math," Brock said, referring to the revenue raisers and cost of the overall package.

The Joint Committee on Taxation estimates the tax bill would cost $3.7 trillion in lost revenue from 2025 to 2034. That does not include a final SALT fix.

The 389-page measure contains only a few mentions of tax-exempt financing. One would lower the 50% threshold test for bond-financed 4% Housing Credit properties to 25%, allowing additional buildings financed with tax-exempt bonds to qualify for housing credits.

The so-called Low Income Housing Tax Credit fix has been a key priority for housing advocates.

"The housing credit provisions in the reconciliation legislation released by the Ways and Means Committee today are a welcome step toward the creation of hundreds of thousands of additional affordable homes in the U.S.," said Emily Cadik, CEO of the Affordable Housing Tax Credit Coalition in a statement.

The bill also broadens the use of proceeds for certain qualified small issue bonds. That's important to the Council of Development Finance Agencies.

"We are particularly excited about improvements to qualified small issues bonds that will allow small manufacturers to finance more with small issue bonds by excluding additional expenses from the capital expenditure limitations under the current law," said Toby Rittner, president and CEO of the CDFA in an email.

The change will allow more research and development expenses to qualify for tax-exempt financing, Rittner said.

"This effectively expands the definition of eligible manufacturing activities that are allowed to be financed and gives American manufacturers a larger opportunity to compete in the global manufacturing market," he said. "CDFA 100% supports provisions like this that make American manufacturing stronger and we look forward to passage of this important piece of legislation."

The bill is projected to increase the deficit by $4 trillion to $5 trillion "and that obviously is a concern from the U.S. government credit standpoint," said Lisa Washburn, a managing director at Municipal Market Analytics.

"I would say my biggest takeaway at this time is that this does nothing to alleviate the worry over the fiscal trajectory of the United States — and that could put pressure on the U.S. credit rating," Washburn said.

Revenue raisers include phasing out billions of dollars in clean energy tax credits created by the Inflation Reduction Act. That includes reducing tax credits for tax-exempt bond-financed clean energy facilities, according to the JCT analysis.

Other offsets include raising taxes on certain philanthropic organizations, rescinding or capping some itemized deductions for the top tax tier, and reducing tax benefits enjoyed by owners of sports teams.

As the legislative process begins, lawmakers may choose to remove some revenue raisers, J.P. Morgan said in a Monday note. "If the currently proposed budget offsets are removed during markup, aspects of the municipal exemption could theoretically be considered for use as a replacement," the bank said.

A provision that makes permanent the alternative minimum tax exemption increase, first enacted in the Tax Cuts and Jobs Act, is "naturally supportive of AMT bond liquidity and valuations in the municipal market," the bank said.

"Everyone is still digesting and analyzing the bill, but at first glance, I imagine folks are taking a quick moment to breathe a sigh of relief," said Brian Egan, NABL's chief policy officer.

"We have a long way left to the finish line, though. Today's release signals the market's advocacy efforts are paying off and that we need to keep them up," Egan said. "I hate to sound cliche, but we're running a marathon and not a sprint here."

Scott Sowers contributed to this report.