President Obama's fiscal year 2014 budget again proposed a 28% cap on municipal bond interest and other tax expenditures for the top 2% of families, despite strong efforts by muni market participants to lobby against it.
Municipal bond participants were overwhelmingly disappointed with the $3.78 trillion budget that would cut deficits by $1.8 trillion, primarily because the 28% cap would significantly increase financing costs for state and local governments and force them to reduce infrastructure projects while permanently damaging the muni market.
"We remain frustrated the administration continues to view limiting the exemption as a cost saving measure, rather than seeing it for what it really is — a significant cost increase for local governments and our residents," said Clarence Anthony, executive director of the National League of Cities.
Similarly, Scott Lilienthal, president of the National Association of Bond Lawyers and partner with Hogan Lovells, said it is disappointing the administration hasn't responded to state and local groups warnings in the past few months about the 28% cap's impact on muni bonds.
While the 28% cap had applied in previous budgets only to those with incomes above $200,000 for individuals or $250,000 for married filing jointly, the new cap would apply to taxpayers in the 33%, 35% and 39.6% tax brackets. .
The budget also implements the so-called Buffett Rule or "Fair Share Tax," requiring households with incomes over $1 million to pay at least 30% of their income, after charitable giving, in taxes. The 28% cap and Buffett Rule would raise $580 billion for deficit reduction by limiting high-income tax benefits, without raising tax rates, administration officials said.
"I think the administration cares about infrastructure and generally supports the interests of state and local governments, but it's a bit of a contrast that they remain wedded to this 28% cap proposal," said Michael Decker, managing director and co-head of the municipal securities division at the Securities Industry and Financial Markets Association.
The Municipal Bonds for America coalition expressed similar concerns about the 28% cap, claiming it will lead to higher local taxes and limited public investment in infrastructure. "These proposals, coming from both ends of Pennsylvania Avenue, are totally out of sync with what I hear from my constituents about our critical infrastructure needs," said Columbia, S. C. Mayor Stephen Benjamin, an MBFA member. The budget proposes a new America Fast Forward Bond program that would provide a 50% federal subsidy rate for original financings of governmental capital projects for public schools and state universities, as well as new money financings for 501(c)(3) nonprofit educational facilities. The 50% subsidy rate would be available for 2014 and 2015, but could not be used for current refundings.
All other taxable, direct-pay AFF bonds would have a 28% subsidy rate, beginning in 2014. The AFF bonds would build off the now-expired Build America Bond program, to attract new sources of capital for infrastructure investments.
AFF bonds with the 28% rate could be used for financing for governmental capital projects, current refundings of prior public capital project financings, short-term governmental working capital financings for governmental operating expenses, and financings for projects and programs that could otherwise be financed with tax-exempt private-activity bonds.
Dealers applauded the AFF bond proposals, but worried that like BABs, they would be opposed by Republican lawmakers or shied away from by issuers because of federal offsets and sequestration cuts to subsidy payments.
"We love direct-pay bonds," Decker said. "They are proven successful. I think they open up the municipal financing market to a whole new category of investors that have benefits that are well documented. I am concerned that there will not be a lot of appetite on Capitol Hill to expand Build America Bonds."
Mike Nicholas, CEO of the Bond Dealers of America, warned that the $1.2 trillion in across-the-board automatic budget cuts known as sequestration, "may harm the perception of the new AFF bonds" because direct-pay bonds were subject to reduced subsidy payments. "Investors and issuers are not going to forget the lesson that the federal government may pull back on its subsidy midstream," Nicholas said.
The president's budget comes more than two months late this year, following very different Senate and House-passed versions of a 2014 budget framework.
Speaking at a press conference in the White House Rose Garden, Obama said his budget, "begins by making targeted investments in areas that will create jobs right now, and prime our economy to keep generating good jobs down the road."
He said his budget is a fiscally responsible blueprint that will grow the economy, create jobs and shrink the national deficit. He emphasized that if lawmakers are serious about deficit reduction, then the reforms he put forth should go hand-in-hand with reforming the tax code to eliminate loopholes and deductions, of which most Americans can't take advantage.
But House Budget Committee chairman Rep. Paul Ryan, R-Wis., rejected the president's budget, calling it "a missed opportunity because it merely ratifies the status quo ... and it takes more from families to spend more in Washington."
There are a slew of muni bond-related proposals, several of which are technical provisions to ease restrictions, but they are viewed positively from market participants.
One such proposal incorporates recommendations from a 2011 Treasury Department regarding tribal economic development bonds. The budget would adopt for Indian tribal governments the state and local government standard for muni bonds without an "essential government function" requirement or a volume cap and allow tribes to issue private-activity bonds for the same types of projects and activities as state and local governments.
"I'm very glad the administration is following Treasury's recommendation to put tribes on the same footing as state and local governments," said Townsend Hyatt, a partner at Orrick, Herrington & Sutcliffe LLP in Portland, Ore. "That is a step in the right direction."
Obama's plan would eliminate the volume cap for private-activity bonds for water and sewer facilities beginning with the date of enactment of legislative authority, a new proposal by the administration. It also would repeal the government ownership requirement for certain types of so called "exempt facility" bonds, which are tax-exempt private activity bonds used for airports, docks, wharves and mass commuting facilities and other projects.
The budget would repeal the $150 million non-hospital bond limitation on the volume of outstanding, nonhospital, tax-exempt bonds benefiting 501(c)(3) bonds.
"It is gratifying that there has been specific attention to the needs of nonprofits for financing," said Chuck Samuels, a lawyer at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC. "We still join with the entire municipal bond community in opposing the 28% cap."
The President also wants Congress to establish an independent National Infrastructure Bank that would provide $500 million of loans and $200 million of loan guarantees to leverage private and public capital to support infrastructure projects of national and regional significance.
The budget would provide $50 billion for up front infrastructure investments, including $40 billion for "Fix it First" projects to repair highways, bridges, transit systems and airports nationwide, as well as $10 billion for competitive programs to encourage innovation in completing high-value infrastructure projects.
The president promised to expedite infrastructure projects by modernizing the federal permitting process to cut through red tape and establishing a goal of cutting time lines in half for major infrastructure projects such as highways, railways, bridges, ports, waterways, pipelines, renewable energy.
In addition, the budget requests $40 billion over five years for high speed, intercity and freight rail. It requests $1 billion for the Transportation Infrastructure Innovation and Finance Act, or TIFIA, which provides loans and loan guarantees for projects.
House Transportation Committee chairman Bill Shuster, R-Pa., said he welcomes the president's efforts to invest but said the budget does not identify a realistic revenue source. "The president's budget repeats his call to increase spending without identifying a viable means to pay for it," Shuster said. "We can't just keep adding to our tab and expect future generations to foot the bill."
Transportation groups mostly supported the president's transportation and infrastructure goals but were unconvinced that the proposals represented a concrete approach to funding.
Funding for clean water and drinking water state revolving funds would be reduced by a combined $472 million.
These proposals, many of which Obama have proposed before, are likely to be dead on arrival with members of Congress, especially Republicans, who have vowed to reject any new tax revenues.
The plan includes a proposal Obama offered House Speaker John Boehner, R-Ohio., at the end of last year during the so-called fiscal cliff negotiations. It would also replace the sequester, which went into effect at the beginning of March.
"I've already met Republicans more than halfway," Obama said. "So in the coming days and weeks, I hope that Republicans will come forward and demonstrate that they're really as serious about the deficits and debts as they claim to be."
