Midwest market participants and researchers say the loss of the municipal bond tax exemption could cost the region's many smaller issuers market access at a time when the region's infrastructure needs are acute.
According to report cards from the
"In the Midwest, you're dealing with a lot of similar age concerns for infrastructure systems that we see in the Northeast, but with different terrains, usage trends and extreme weather patterns," said Maria Lehman, ASCE's 2023 president. Those extreme weather patterns now include previously unlikely threats like wildfires spreading from Canada toward Michigan.
"Agencies and utilities have to account for extreme cold fronts and wind events that are less common in the many parts of the U.S," she said. "The Midwest is [also] starting to see more irregular weather patterns like extreme heat, flooding and wind."
The ASCE estimates the U.S. infrastructure investment gap at $3.7 trillion, and had been expecting tax-exempt muni bonds to finance $3 trillion in new infrastructure investments by 2031, Lehman said.
"State and local governments fund roughly 75% of infrastructure projects in the U.S., and they will struggle to meet those needs without tax-exempt bonds," she said. "The federal government cannot cover all the projects needed to keep our built environment operating to the standards we require — not even close."
Aaron Heintz, capital finance director for the state of Wisconsin, said the loss of the tax exemption would raise borrowing costs for local governments and could delay or cancel key infrastructure projects.
"Higher costs would not only affect the quality and scope of local infrastructure... but also have broader economic consequences," he said.
The loss of the tax exemption threatens not only to
Eliminating the tax exemption could undermine projects like the
The Stillwater Bridge project connecting Wisconsin and Minnesota 19 miles east of St. Paul, also known as the
The elevated crossing carrying U.S. 36 replaced an 80-year-old lift bridge.
As
Some of those half-measures are outlined in
Co-author Justin Marlowe, director of the CMF, told The Bond Buyer that one of the report's key contributions is its look at the tax exemption's role in smaller and rural communities.
"We learned a lot in doing this analysis," he said. "Very germane to the Midwest is this question of market access for small issuers."
The threatened loss of the tax exemption is of particular concern for smaller issuers, said Beth Coolidge, head of public finance at Oppenheimer & Co.
"There is currently a well-developed investor network for smaller deals in the tax-exempt market," she said. "However, this network does not exist in the taxable market. The concern is that smaller issuers who are funding vital projects such as improvements to water and sewer could lose market access."
Most taxable bond indexes only include single-CUSIP bonds with at least $300 million minimum par amount outstanding, but two-thirds of new municipal issuers have a par amount of less than $25 million.
"When you do a taxable bond issue, there is a perception that you need to have a larger block size," Erdman said. "Looking at small issuers, this is just another potential impact on their ability to directly access the capital markets, as within the past year, proposals have been floated that connect small issuers with...
In the policy brief, the academic researchers looked at outstanding municipal debt as of Jan. 15 and found that on average, 52% of issuers in a congressional district are below the $30 million threshold they define as a small issuer.
"I believe for virtually every one of the states in the Midwest, it's closer to something like 60 to 70% of the issuers within their congressional district are below that $30 million threshold," Marlowe said.
"That is a uniquely Midwest consideration around market access," he said. "In the Midwest we have a much larger preponderance of bank qualified issuers, a lot more infrequent borrowers, a lot more issuers that are going to the market less frequently and for smaller amounts. They are the ones who stand to lose the most."
The exemption encourages issuers to pool their revenues and take on big projects. Without it, the market could see a fragmentation of state and local service provision, with each jurisdiction prioritizing only its own immediate needs and giving short shrift to broader, higher-impact infrastructure projects, the report says.
"When you take out the incentive for that kind of cooperation, and local issuers have to go it alone, that's done at higher cost, that's done in a more fragmented way," Marlowe said. "Then it suddenly becomes about everybody having to borrow against their own revenues. And generally we don't see a lot of larger regional revenue sources. It tends to be much more localized, particularly in property taxes. And so… local residents end up bearing more of the cost."
Illinois and Missouri are prime examples of how that dynamic could play out, he said. Both states have a major metropolitan area — Chicago and St. Louis, respectively — and a lot of smaller rural counties outside it.
"Think about the Illinois Finance Authority, which is one of the largest issuers out there," Marlowe said. "And when you get into the data you realize how much of the borrowing that the IFA does really does benefit downstate, rural communities, on a per capita basis, at least, in a much larger way than it does the Chicagoland municipalities."
Curtailing or ending the exemption "would have disproportionate impacts on rural communities," Marlowe said.
Members of Congress from the Midwest have been key players in the unfolding debate around the tax exemption. Rep. Don Bacon, R-Neb., recently
"In Nebraska, where fiscal budgets are tight and rural areas need affordable ways to grow, the tax- exempt municipal bond is a lifeline for getting much needed projects completed without having to increase taxes or sacrifice services," Bacon told The Bond Buyer.
Rep. Rudy Yakym, R-Ind., sits on the House Ways and Means Committee and formerly served on the Indiana Finance Authority.
"Municipal bonds are an essential tool that allow state and local governments to invest in critical infrastructure like police and fire stations, wastewater treatment facilities, and hospitals. In my district alone, we have $10.6 billion in outstanding municipal bonds," Yakym said in a statement. "Without the federal tax exemption, the cost of this debt would skyrocket."
A staffer for Rep. Gwen Moore, D-Wis., said municipal bonds are "a fabulous tool" for state and local governments to build critical infrastructure.
"Municipalities should be rightly concerned that Republicans will eliminate tax-exempt bonds," the staffer said.
Heintz, the Wisconsin finance director, said smaller or financially struggling local governments would be hardest hit by the loss of the exemption.
"These groups would experience higher borrowing costs, delayed or reduced infrastructure development, and potential increases in taxes or fees to compensate for the loss of financing flexibility," he said. "The overall economic health of local communities and the state could be significantly harmed."
Erdman noted
However, a P3 capital stack typically contains some element of tax-exempt bonds, said Jennifer Fredericks, a director at Baker Tilly.
Losing the exemption "causes problems for any construct, regardless of size and regardless of what the structure of the deal is," she said.
"The loss of tax exemption would make it more expensive to fund our infrastructure, which in turn means it would cost taxpayers more," said Ted Nelson, deputy director of communications for the Cook County, Illinois, Bureau of Finance. "Without the tax exemption, the maintenance on existing infrastructure could also potentially be deferred, which would increase the cost of future maintenance."
