The Senate Finance Committee released a paper Wednesday containing tax reform options for economic and community development, including repealing tax exemption for all governmental and private activity municipal bonds, replacing tax-exempt bonds with direct-pay and traditional tax-credit bonds, and capping the value of tax-exemption.

The discussion paper includes options that would ease restrictions on tax-exempt bonds such as repealing the governmental ownership requirement for bonds used to finance airports, docks, wharves and mass commuting facilities, which was proposed in President Obama’s fiscal 2014 budget and was estimated to cost $4 billion over 10 years.

The 15-page paper, the sixth in a series, focuses on tax-exempt financing, tax incentives for housing, tribal government financing, and the state and local tax deduction, includes a wide range of options that have been suggested by witnesses at committee hearings, tax experts and deficit reduction groups.

The paper stresses that the tax reform options are not necessarily endorsed by either chairman Max Baucus, D-Mont., or ranking member, Orrin Hatch, R-Utah.

It also says, “Members of the committee have different views about how much revenue the tax system should raise and how tax burdens should be distributed.” 

“Tax reform provides an opportunity to simplify tax expenditures for economic and community development and, if members of Congress decide to preserve these provisions, make them more efficient,” the paper says.

According to the paper, tax experts also have differing concerns about tax-exempt bonds. Some argue that they are “intended to reduce the borrowing costs to state and local governments by providing a tax exemption for investors on the interest they receive,” the paper says. “However, according to the Congressional Budget Office, about 20% of the tax subsidy does not accrue to the state and local government by lowering their borrowing costs.”

Another concern, the paper says, is “federalism” and the idea that “it is not an appropriate role for the federal government to assist state and local governments by, for example, helping to pay for local infrastructure or services.”

Municipal market participants are disappointed the finance committee includes suggestions to eliminate or limit tax exempt bonds. “The perception issuers and investors have about direct–pay bonds has been permanently damaged by the reduction in reimbursement payments due to sequestration,” says Susan Collet, senior vice president of government relations with the Bond Dealers of America. “These bonds can work as an option in the market, but not as a substitute. Proposals in various forms to cap the value of the exemption harm current and future investors and raise borrowing costs — and those consequences don’t solve our fiscal crisis.”

Chuck Samuels, a lawyer at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC, calls the report an “interesting smorgasbord of options for discussion.”

“It includes not only the usual list of abolition of, and limitations on, tax exempt bonds but even liberalization and the substitution by direct-pay bonds,” Samuels says. “It probably fairly displays the parameters of the current discussion around muni bonds but really does not provide a guide or proposal for action one way or another. As is usually the case with Hill analyses of tax-exempt bonds, there is an assumption, devoid of real world experience, that this form of financing is inefficient.”

Lars Etzkorn, program director for the National League of Cities’ center for federal relations, is surprised to see the finance committee floating ideas to cap or eliminate municipal bonds. The efficiency of the municipal bond market has long been debated and it’s a retread in the committee’s report, he said. 

“We know that if the municipal bond interest exemption is eliminated or capped, Washington would be mandating a local tax increase on hometown residents,” Etzkorn says. “As cities have to pay more in order to build the infrastructure in this country, they will have to pass that on to residents.”

For Indian tribal governments, the report suggests modifying tax-exempt bonds for tribes so that they are not subject to financing projects based on “essential government functions,” a requirement that does not currently apply to states and localities. This was proposed most recently in Obama’s fiscal 2014 budget and estimated to cost $1 billion over 10 years. It was also the subject of a 2011 Treasury Department report that suggested bond financing improvements for Indian tribal governments.

The paper proposes conforming private activity bond standards to those of state and local governments for tribes. It also suggests creating a 10-year, tax-free zone for selected areas of Indian country in which economic activity would not be subject to any federal, state or local income, sales or excise tax.

For housing, the paper proposes several options for the sacred mortgage interest deduction including gradually repealing it, limiting the deduction, and converting it to an above-the-line deduction or a credit. The paper also suggests repeal of the low-income housing tax credit or replacing it with an equivalent reduction in tax on rental income. The tax code provides tax credit and tax-exempt bond financing for affordable rental housing, the LIHTC, which is administered by state housing finance authorities.

In addition, the paper proposes authorizing states to require out-of-state vendors to collect sales taxes, also known as an online sales tax. Earlier this month the Senate overwhelmingly passed the Marketplace Fairness Act that would enable states to do just that.

The paper also contains options for Congress to authorize states to establish uniform tax rules.

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