WASHINGTON — Municipal market participants are still weighing the implications of a bill that would eliminate tax-exempt bonds and shift the muni market wholesale to a tax-credit subsidy, with many warning it would hurt state and local governments still recovering from the recession.
Sens. Ron Wyden, D-Ore., and Judd Gregg, R-N.H., on Thursday unveiled the Bipartisan Tax Fairness and Simplification Act of 2010, which would fundamentally remake the tax code, including how the federal government subsidizes debt issued by state and local governments.
The senators issued statements highlighting the big-ticket provisions: halving the amount of individual tax brackets, making the top individual tax rate 35%, eliminating the alternative minimum tax, and establishing a flat corporate tax rate at 24%.
But the bill also proposed making all municipal debt taxable, and subsidizing it by providing individual investors with a tax credit equal to 25% of interest costs. It also would prohibit any advance refundings of municipal bonds.
“It has so many implications that it’s almost hard to fathom,” said Chris Mier, managing director at Loop Capital Markets. “It basically throws everything up for grabs if it were to happen. The market is not ready for a 100% tax-credit market and the elimination of tax-exempt bonds.”
Mier warned that if the proposal became law, it would “cause chaos and confusion at a time when municipalities are under considerable fiscal stress.”
One dealer who did not want to be identified said issuers would never allow Congress to approve the measure.
“I honestly believe that state and local officials would protest so much because of the higher cost of schools, highways .... The cost of everything would go way up,” he said.
The dealer also questioned the proposed credit rate. “No one in Washington could tell you what that subsidy is worth,” he said.
Richard Ciccarone, director of research at McDonnell Investment Management, said the proposal could reverse what investors would be most attracted to munis. Under the tax-exempt model, investors in the highest tax brackets get the biggest benefit from buying bonds, whereas under the tax-credit proposal, investors in the lowest brackets would stand to gain the most.
Michael Decker, managing director and co-head of the Securities Industry and Financial Markets Association’s muni securities division, pointed out that individuals in lower tax brackets typically have less investable income to pump into a tax-credit bond market, and issuers would still need to entice higher-bracket investors.
“In order for the product to clear the market among investors where there is enough capital to cover the borrowing needs of the issuers, you have to move up to higher-bracket payers,” he said, adding that would require higher interest rates. “In the end, it’d be higher borrowing costs for state and local governments relative to the status quo.”
Some issuers said the bill would lead to further federal involvement in state and local finance.
“It confirms our worst possible fears of an unwanted federal interference in our ability to raise capital,” said Ben Watkins, director of Florida’s Division of Bond Finance.
The National Association of Bond Lawyers said the current arrangement in the muni market should remain untouched.
“NABL remains committed to believing that tax-exempt bonds and tax-credit bonds are complimentary financing options and neither one should be eliminated,” said Kathy McKinney, a shareholder at Haynsworth Sinkler Boyd PA and current NABL president. “State and local governments have been creative in developing financing structures that work for their particular situations and we should not discourage that.”
Meanwhile, the Senate yesterday easily approved a $15 billion jobs package that would allow the several types of tax-credit bonds to be issued as direct subsidy bonds, as well as extend the surface transportation law and put nearly $19.5 billion into the highway trust fund.
Senators voted 70 to 28 to approve the bill, which now advances to the House. Lawmakers in the House approved their version of jobs legislation in December, which would extend the Build America Bond-style subsidies to just two tax-credit bond programs — qualified school construction bonds and qualified zone academy bonds.
Under the Senate measure, QSCBs, QZABs, qualified energy conservation bonds, and new clean renewable energy bonds could all be issued as direct-payment bonds. In addition, large issuers would receive a subsidy rate of 45% of interest costs and small issuers would receive a 65% rate under the measure. Small issuers would be those that sell less than $30 million of bonds in the calendar year.
However, both those subsidy rates would fall below what issuers could receive under the tax-credit bond mode. Current tax-credit programs offer tax credits roughly equal to 70% and 100% of interest costs, depending on the program.
New York City Comptroller John Liu complained yesterday that the 45% subsidy is far too low.
“Approval of a 45% subsidy rather than the original interest-free model will place additional strain on an already overburdened budget,” he said. “QSCBs at a 100% subsidy rate are critically needed not just for jobs, but also for schools and classroom seats that we so desperately need.”
In contrast, the House bill would modify the two tax-credit bond programs that can be used to finance school construction and improvement projects, but would give issuers direct payments equal roughly to the credit rate on the bonds.
The Senate bill also would extend the Safe, Accountable, Flexible, Efficient Transportation Equity Act: a Legacy for Users, through the end of this calendar year. The programs under SAFETEA-LU have been kept afloat by short-term extensions since Sept. 30, 2009.
In addition, it would transfer into the highway trust fund $14.7 billion for highways and $4.8 billion for transit, to make up for interest the fund has lost due to a ban on its interest-earning ability.
The bill also would repeal that ban and reverse a recent mandatory rescission that took away state transportation departments’ ability to obligate $8.7 billion of unused funds.
But a group of 23 House Democrats yesterday warned House leaders that the Senate bill’s transportation provisions are “unfair to the taxpayers of 46 states” and “unresponsive to the whole nation’s infrastructure and job creation needs.”
The provisions would allocate a lot of funding to California, Illinois, Louisiana, Washington and nine other states, while providing 31 with $5 million or less and 22 of those with none, they said.
“In other words, more than half of states would see at most de minimus investment from two important [transportation] programs meant to benefit the entire nation,” they told House Speaker Nancy Pelosi, D-Calif., and Majority Leader Steny Hoyer, D-Md., in a one page letter.
The House jobs bill, in contrast, would allocate these funds through the U.S. Department of Transportation and based on a competitive selection process, they said.
Meanwhile, the Senate last night was expected to take up a bill that would extend expiring provisions for a short term, but none of the provisions involved municipal bonds.
The chamber is expected to take up a longer term extenders bill next week that includes muni provisions.
An extenders bill proposed by top Senate tax-writers earlier this month would extend New York City’s Liberty Zone bond program through the end of the year and relax mortgage-revenue bond limitations for federal disaster areas through this year.
It would also extend through 2010 the ability of taxpayers to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction typically permitted for state and local income taxes.
