WASHINGTON — The National Association of Bond Lawyers issued an eight-page white paper Monday designed to quash what it views as a misconception that tax-exemption predominantly benefits upper-income taxpayers.
Rather, NABL argues, that tax exemption overwhelmingly benefits state and local governments that are able to borrow at lower interest rates and invest more in infrastructure as a result of the tax preference.
Kristin Franceschi, NABL president and a partner at DLA Piper LLP, said that one of her goals during the past year has been to publish an educational paper on tax exemption for market participants and those associated with public finance.
"We thought it was good for other stakeholders to understand ... that if you affect this, you are affecting borrowing costs for the local hospital down the road or your kid's charter school," Franceschi said. "We want to make sure it's a tool you can use as an educational resource."
The paper highlights Internal Revenue Service statistics that show more than 5.3 million households with incomes below $250,000 received interest from tax-exempt bonds in 2009, representing more than 55% of all tax-exempt interest paid in that year.
"The burden of eliminating or curtailing the exemption will not fall primarily on upper-income taxpayers, but on state and local governments and their taxpayers and ratepayers," the paper said. "Exempting state and local government bonds from federal tax is consistent with the reciprocal principles of federalism and has a long-standing historical basis."
The paper examines the impact of eliminating or curtailing tax exemption on state and local governments and finds that, among the effects, it would increase borrowing costs and ultimately pass those costs onto taxpayers. If state and local governments are forced to pay higher borrowing costs due to the elimination of tax-exemption, taxpayers would see it in the form of increased fees on water and sewer, tolls, and sales and property taxes, NABL said.
As lawmakers on Capitol Hill consider comprehensive tax reform and look to close loopholes and eliminate tax preferences for lower rates and a more efficient tax code, eliminating or curtailing tax exemption has been one option under consideration.
But NABL argues that some provisions in the tax code, such as tax exemption, advance the goals of infrastructure investments, job creation and economic growth that will help reduce the federal deficit.
The paper also mentions that some proposals to maximize tax revenues by restricting or eliminating the exclusion of interest from municipal bonds would apply retroactively to all outstanding bonds.
"A retroactive change in the taxation of outstanding state and local government bonds would result in an immediate decrease in the market value of much of such outstanding debt, a loss that will be felt by current holders of such bonds, more than three-fourths of whom are retail investors, many of whom are middle income and at least some of whom are older Americans," NABL said in its paper.
If there are changes to tax exemption, "investors may adjust their holdings either at once or over time to other tax-advantages investments and strategies to reduce the taxes they pay," NABL warned. If investors reallocate their portfolios, the expected revenues from the elimination or limitation of tax-exemption may not be realized and might not be significant for federal deficit reduction or base broadening.