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Sen. Wyden Touts Tax-Credit Bonds, Hits Tax-Exemption for New Munis

Sen. Ron Wyden on Tuesday underscored his opposition to tax exemptions for new muni bonds, saying it is inefficient and that tax-credit bonds would benefit a broader set of taxpayers, not just high-net-worth individuals.

The Oregon Democrat touted the tax-credit bond proposal at a tax-reform panel discussion at Johns Hopkins University. Last week, Wyden and Sen. Dan Coats, R-Ind., introduced tax-reform legislation that would eliminate tax-exempt interest for new state and local debt in favor of tax-credit bonds. The bill also would eliminate advance refundings for governments and nonprofit organizations. It also would eliminate the alternative minimum tax and establish three, instead of six, income tax rates at 15%, 25% and 35%, for individuals.

Studies have shown that municipal bonds “disproportionately … shelter those who are most affluent,” Wyden said, adding that a tax-credit bond proposal would be more inclusive, and would engage all taxpayers, not just wealthy earners in the highest brackets. More investors will be interested in buying state and local debt with a tax-credit bond system, he said.

Wyden’s move to tax-credit bonds has been criticized by market participants because the current market for such securities is thin and has inefficiencies of its own. For instance, tax-credit bond issuers often have to add a supplemental coupon to the tax credit to sell the bonds to investors.

When asked if his proposed tax-credit bond proposal would catch on with investors, Wyden pointed to the success of the Build America Bond program.

“With Build America Bonds, we saw enormous success,” he said. BABs are “a perfect example” for the tax-credit bond proposal, he said.

BABs offered issuers the option to issue either taxable, tax-credit bonds or direct-pay bonds under which the federal government would pay them a subsidy equal to 35% of interest costs, in lieu of providing investors with tax credits. During the two-year life of the BAB program, no issuer sold BABs with the tax-credit option.

The call to eliminate tax-exempt interest on state and local debt has gained momentum as part of a larger initiative for deficit reduction and tax reform. In December, President Obama’s National Commission on Fiscal Responsibility and Reform, headed by former Sen. Alan Simpson and Erskine Bowles, chief of staff in the Clinton administration, called for tax-exempt interest to be eliminated.

Before Wyden spoke, Paul Weinstein, one of the panelists who was a senior adviser on the president’s deficit commission, talked about a tax-reform plan that he co-authored and released Tuesday that would phase out tax-exempt interest on state and local debt.

The plan recommended tax-exempt interest on state and local debt be gradually phased out over five to 10 years. The plan’s other author, Marc Goldwein, policy director at the Committee for a Responsible Federal Budget, also served on the deficit commission as an associate director.

One of the other panelists, Alan Viard, a resident scholar at the American Enterprise Institute and formerly an economist at the Federal Reserve Bank of Dallas, said the phase-out of municipal tax-exempt interest is important because the current municipal bond system is inefficient.

Municipal bonds encourage “additional capital spending for state and local governments,” Viard said. Most of the tax-exemption subsidy “really is just a windfall gain to the highest tax bracket” earners, he said, adding that he favors a gradual phase out and that keeping the tax exemption for existing municipal bonds “is absolutely imperative.”

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