WASHINGTON — A congressional research report has underscored the high cost of tax-exempt debt to the federal government just as some members of Congress are weighing whether to propose curbs on such debt.
State and local tax-exempt borrowing will cost the federal government $161.6 billion from 2010 through 2014, according to a report published Thursday by the Congressional Research Service entitled “State and Local Government Debt: An Analysis.”
The report cites December statistics from the Joint Tax Committee.
In addition, tax-exempt bonds are not a cost-effective means of transferring resources from Washington to state and local governments, the report said.
The CRS report was published as market participants warned Friday that some members of Congress might propose eliminating the federal tax exemption for new municipal bonds as part of broader a tax reform plan.
Rosemary Becchi a public finance attorney with Patton Boggs LLC and John Buckley, a Georgetown University law professor, each issued the warning at The Bond Buyer and Bond Dealers of America’s Third National Municipal Bond Summit in Miami.
They said lawmakers could propose legislation to eliminate the deduction of state and local taxes and mortgage interest from federal taxes, as well as federal tax-exemption for new muni bonds.
The CRS report analyzed state borrowing during the recession and found that states zoomed ahead with capital projects financed with municipal and federal borrowing just as their general fund spending for projects slowed.
The recession officially lasted 18 months, from December 2007 to June 2009, according to the National Bureau of Economic Research. In fiscal 2009, from Oct. 1, 2008, to Sept. 30, 2009, state general fund financing for capital projects decreased 35.9% while federal funding and debt financing increased, according to the CRS.
States relied on municipal borrowing for 32.5% of their capital projects in fiscal 2009. General funding was just 3.5% for the year, the report found.
It also showed state borrowing increased during the last recession compared with the fiscal 2002 downturn. The level of state debt rose to 69.9% of general revenue in fiscal 2009 from 59.9% in 2002. The ratio could increase further in fiscal 2011 and 2012 as the economy recovers in fits and starts and as the housing market continues to lag, the report said.
However, state and local borrowing has plummeted in recent months. For the first quarter ending March 31, municipalities issued the lowest amount of debt in 10 years. While issuers found willing buyers during the recession — thanks in part to the Build America Bond program — demand for munis now is weak.
While the BAB program expired at the end of last year and key Republicans have opposed reinstating it, the CRS said BABs are a more efficient alternative to tax-exempt bonds.
Four bills introduced in the House would renew the BAB program in some form. In the Senate, Sen. Ron Wyden, D-Ore., had been considering proposing a BAB program to fund transportation efforts. But, due in part to opposition from Republicans, Wyden is now expected as early as this week to introduce legislation that would create a new type of tax-credit bond would be used to solely to finance transportation projects.
The CRS report also raises concerns about pension obligation bonds. Governments issue taxable POBs to fund their pension systems with the hope that the investment returns will exceed the interest cost on the bonds. POBs can be used successfully to gamble on the spread between borrowing costs and investment returns, but usually are sold by fiscally stressed issuers that are in a poor position to shoulder investment risk, according to the report.
In February, Illinois sold $3.7 billion of taxable, eight-year general obligation bonds to cover its 2011 pension contribution.