Tax Committee Members, Experts Question Tax Exemption for PABs

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House Ways and Means Committee members on both sides of the aisle and experts agreed on Tuesday that they should re-examine the tax laws for tax-exempt private-activity bonds.

They also differed about the economic benefits of municipal bonds at a tax reform hearing that focused on tax provisions affecting state and local governments, including muni bonds, the exclusion of state and local government taxes from the federal income tax, and pensions.

Most of the discussion among the committee members and the four witnesses revolved around the benefits of maintaining tax-exempt bonds versus completely eliminating them. Republican committee members repeatedly voiced concern about a recent New York Times article that highlighted abuses in the private-activity bond market.

Committee chairman Rep. Dave Camp, R-Mich., asked each of the witnesses if there was a policy difference between federal subsidies for government bonds that are used for public purpose and private activity bonds, which benefit private projects.

He also asked if it was appropriate that federally subsidized borrowing helped build the offices of Goldman Sachs and the Bank of America tower in Manhattan and if there are any rules that Congress could change as it relates to private activities.

The Tax Foundation’s president Scott Hodge argued that tax exemption is a “very inefficient way for the federal government to subsidize such local spending and said that it has led to an explosion of state and local debt.” He said he would eliminate both general purpose and private activity bonds.

While Hodge didn’t attribute all of the state and local government borrowing to the muni bond exemption, he emphasized that, “this source of cheap financing does create a moral hazard that can only be cured by eliminating the exemption.”

Hodge claimed that $1 million in tax-exempt bonds can confer $15,000 in interest savings to the local government and $6,000 in tax savings to the bondholder. So, “in order to generate a ‘public’ benefit of $15,000 the federal government actually forgoes $21,000. This seems like an expensive way to subsidize local investment,” he said.

Hodge said that about one-third of the tax exemption benefits bondholders and leads to higher property taxes. He said it would almost be cheaper for the federal government to just give state and local governments cash.

A Joint Committee on Taxation report last week said, “the loss of federal receipts is greater than the reduction in the tax-exempt issuer’s interest costs.” Additionally, a Congressional Budget Office report issued earlier this month found that $30 billion in revenues was lost in fiscal year 2011 due to tax exemption from municipal bonds.

Former Municipal Securities Rulemaking Board chairman Kit Taylor did not support full elimination of municipal bonds, but argued that if the federal government continues to allow state and local governments to issue tax-exempt bonds, it should be limited to true public purposes only and not for private projects.

“I do not see a reason there should be any kind of benefit to private corporations and private decision makers,” Taylor said.

Tuesday’s hearing is the latest in a series of hearings aimed at a comprehensive overhaul of the tax code this year. John Buckley, former Democratic House Ways and Means tax counsel, argued that the PAB market is a small section of the overall municipal bond market and that most tax-exempt bonds are general obligation.

“If this committee were to look at anything in this area, I would look at the [PAB] rules,” Buckley said. He added that the abuses outlined in the New York Times article were largely due to one-time disaster recovery programs. 

Buckley, the architect of the Build America Bond program, also said that dramatic reductions in marginal tax rates, which have been proposed by House Republicans as part of comprehensive tax reform, “should not be financed by changes that could reduce the needed public infrastructure investments unless the Congress is prepared to finance those investments with appropriated funds.” Ranking committee minority member Rep. Sandy Levin, D-Mich., said the hearing suggests there is a need for further inquiry into PAB rules. He also said that “there is value in considering” the various proposals to limit deductions and tax preferences, such as President Obama’s 28% cap, as Congress seeks a balanced approach to deficit reduction.

 Rep. Richard Neal, D-Mass., who recently introduced legislation to make permanent the BAB program at a lower subsidy rate, said,  “tax-exempt municipal bonds are the most important tool in the U.S. for financing investments in schools, roads, bridges, water and sewer systems.  The reality is these projects just wouldn’t happen without muni bonds.”

Neal noted that if the Bowles-Simpson deficit reduction proposal had been in place to tax newly issued muni bonds, state and local governments would have had to pay an estimated additional $495 billion in interest costs for the $1.65 trillion of infrastructure investments made during the 2003 through 2012 period.

 State and local groups also weighed in on the conversation warning of the serious consequences of eliminating muni bonds. Stephen Benjamin, mayor of Columbia, S.C., submitted a statement on behalf of the Municipal Bonds for America coalition that summarized why arguments against tax exemption suffer significant flaws.

“In arguing that tax exemption only benefits high-income taxpayers, critics fail to recognize that the tax exemption broadly benefits every American in the form of basic infrastructure, lower state and local taxes and lower utility rates,” Benjamin said.

Implicit in investments in water, transportation and other core infrastructure “are jobs that are critical to nation’s economic recovery,” he said.

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