Public finance academics have waded into the Capitol Hill debate over tax-exempt municipal bonds, warning in a policy brief that cutting the exemption would hurt infrastructure investment in the U.S. and pressure local and state budgets.
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Well-known muni finance academics Justin Marlowe at the University of Chicago's Center for Municipal Finance and Martin Luby at the University of Texas Austin's Center on Municipal Capital Markets — which was
"Both of our centers received a lot of calls from various groups of people just trying to get a better sense of the exemption and what the potential impacts would be and what the justification was to begin with," Luby said. "So we thought we would put together a report that's concise but also comprehensive," he said. "It was useful to go back to the academic research and see what the research says about many of the various facets of the industry and aggregate that research into a narrative."
The debate is heating up as Congress is set to take up a massive tax package and lawmakers, on the hunt for pay-fors to cover the cost,
Echoing what's become a theme among municipal market advocates, the report argues that eliminating the exemption would most hurt smaller issuers, who make up the majority of the diverse market although not the bulk of outstanding bonds.
"Ending or scaling back the exemption would force tens of thousands of these smaller issuers to either compete for investor attention in the taxable bond market, or reduce their own investments in public infrastructure," the paper warned.
About 52% of issuers in a Congressional district are below the $30 million threshold, according to ICE data, the paper said.
"In six Congressional districts more than 90% of issuers are below that threshold. In short, many small issuers would need to fundamentally alter their debt management practices to attract adequate investor attention in a taxable municipal market," the report said. "This would entail significant additional transaction costs on top of the higher borrowing costs. Though, it should be noted that absorbing some of these additional transaction costs, such as developing better disclosure, could enhance the functioning and efficiency of the overall municipal market."
The pair consider a proposal to replace the tax exemption with a direct subsidy bond program, ala the 2009 Build America Bond program. On the pro side, a direct pay program would address some long-standing criticism of the tax-exempt market related to efficiency, equity — by eliminating tax benefits that just go to higher-income investors — as well as budget transparency and the limited investor base, they said.
"However, a direct subsidy program more greatly exposes state and local governments to the whims of the federal budget process," the paper said, as has been
The subsidy level would also dilute the potential federal budget benefit, they added.
Eliminating tax-exempt private activity bonds, another potential proposal, would likely dampen investment in key infrastructure sectors like airports, ports hospitals and colleges and reduce interest in public-private partnerships, which were a priority under the first Trump administration, the paper said.
Affordable housing, an area of concern among both parties in recent years, may be "especially impacted by the elimination of tax exemption for PABs," they said.
Targeting certain industries, like higher education or healthcare, would likely bring in only modest new revenue and force states and local governments to cover their costs, the paper said.
"Although it is inevitable that tax policy will reflect political values, using the tax code for punitive purposes risks undermining public confidence that the tax system is both designed and administered evenhandedly," Marlowe and Luby wrote.
Bond Dealers of America CEO Mike Nicholas noted the importance of the policy brief as an independent analysis.
"They're not taking a position on really any of the reforms but are clearly highlighting the importance of municipals for infrastructure," Nicholas said. "They're also drilling down into the importance of municipal finance for smaller issuers, and that's not just [general obligation] issuance, that's across the board, including private activity bonds."
The American Securities Association called the brief a "crucial piece of new information."
"Before Congress considers updating its tax policy, we urge policymakers to use this academic report as the foundation to make educated decisions on a key component of infrastructure financing," said ASA President and CEO Chris Iacovella in a statement.
