WASHINGTON – President Trump’s proposal to eliminate the deductibility of state and local taxes could impair governments’ budgets and creditworthiness, potentially affecting their bond issues, according to a tax expert.

“One of the biggest issues for munis is the repeal of the real property tax deduction,” which is included in deductions for state and local taxes, said John Buckley, former chief tax counsel for House Ways and Means Committee Democrats.

"People are feeling very confident that the [arbitration] rule will not become effective" after President-elect Trump's victory, said one expert.
President Trump
Trump's tax plan would spell trouble for state and local governments. Image: Bloomberg

The repeal will make it harder for state and local governments to pass increases in tax rates to provide revenues for their budgets and the repayment of bonds.

“If the ultimate ability to repay munis and maintain the creditworthiness of the state or local government is the ability to impose taxes, this will make it more difficult to impose taxes,” Buckley said.

The Trump tax plan also would discourage home buyers and therefore potentially lower property taxes by essentially eliminating the mortgage interest deduction for most taxpayers-- despite what the administration’s one-page tax plan brief claims, according to Buckley.

The after-tax cost of owning a home will be increased because, “You won’t be able to deduct your mortgage interest and you won’t be able to deduct your real property taxes,” he said.

The Trump plan does not really protect the mortgage interest and charitable giving tax deductions for most Americans, as advertised. It only protects them for wealthy individuals, he said. That’s because Trump is proposing to double the standard deduction to $24,000 for couples and is likely to repeal personal exemptions as well. For most lower and middle income earning couples, the new $24,000 standard deduction will be far higher than any deductions they would get for mortgage interest or charitable contributions so they simply won’t take them. Taxpayers under the current system can take either the standard exemption or itemize deductions.

The tax system this year provides a standard exemption of $12,700 for married couples and personal exemptions of about $4,000. A taxpayer can claim the personal exemption for his or her self and one for their spouse if married, as well as one for each child. So a married couple with two children still comes out better under the current system at almost $29,000 than the $24,000 standard exemption with the Trump plan.

Trump administration officials haven’t said they would eliminate the personal deductions, but Buckley thinks they would do so because the tax plan seems modeled after the one proposed years ago by former Rep. Dave Camp, the Republican from Michigan who chaired the House Ways and Means Committee. Camp doubled the standard deduction, repealed most itemized deductions, and repealed personal exemptions, he said. House Republicans also propose the elimination of personal exemptions in their tax plan.

The mere mention of Camp’s plan scares muni market participants because he also proposed capping the value of the tax exemption for muni bond interest at 25% as well as eliminating the tax exemption for both private activity bonds and advance refunding bonds issued after 2014.

Buckley did a quick back-of-the-hand calculation and said couples would have to have mortgages of over $500,000 to be able to deduct more mortgage interest than the proposed new $24,000 standard deduction. “Not many people have itemized deductions in excess of $24,000,” he said.

The National Association of Realtors raised the same concerns about the mortgage interest deduction in a statement released Wednesday that panned the tax plan. “By doubling the standard deduction and repealing the state and local tax deduction, the plan would effectively nullify the current tax benefits of owning a home for the vast majority of tax filers,” said William Brown, president of the group.

The seven major state and local groups issued a release saying they are, “extremely concerned that President Trump’s proposal includes eliminating the deductibility of state and local taxes.”

“Eliminating or capping federal deductibility for state and local property, sales and income taxes would represent double taxation, as these taxes are mandatory payments for all taxpayers,” the groups said, adding, this would “also effectively increase marginal tax rates and shrink disposable income, potentially harming the U.S. economy.”

The groups urged Congress to maintain not only the state and local deduction but also the tax exemption for municipal bond interest.

David Parkhurst, general counsel of the National Governors Association, agreed with Buckley on Friday, saying the concern about the elimination of federal deductibility for state and local taxes is that, “state and local governments aren’t going to have the nimbleness, the flexibility, to deliver the public goods and services that their citizens demand.”

He added, “If I’m a public issuer, I’m dependent on the revenue streams from property, sales and income taxes to secure the bonds. So if there’s going to be some risk to those income streams, investors are either going to shy away [from the bonds] or they’re going to ask for a risk premium that jacks up my costs.”

The Rockefeller Institute of Government also weighed in on the Trump tax plan on Friday. "The elimination of the deduction for state and local taxes is a huge issue for states like California and New York, that rely heavily on income taxes, and for local governments that depend on property taxes," the group said in a blog. "Many of the states whose residents would be most affected by ending the deduction are "blue states," ones that didn't support the president in the last election."

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