A book written by Wall Street whistleblower Michael Lissack that supports the notion of paying for budget shortages by eliminating the tax-exempt status of municipal bonds is spurring critiques of his findings and recommendations.
"Lissack points to the persistent federal deficits as a rationale for eliminating the cost of the tax-exemption, yet the cost to the government is a soft-dollar cost," said Pat Luby, head of municipals, senior market municipal strategist for CreditSights.
"His proposal to convert the tax-exemption to a direct subsidy or tax credit would convert some or all of those soft-dollars into hard-dollars that would need to be budgeted and appropriated, and thus subject to the political realities of future Congresses."
Lissack posits in his book, "The Inefficiency Of Municipal Tax Exemption," that the municipal bond market is broken beyond repair and needs to be replaced.
"With the existing system, states and local governments issue bonds. Uncle Sam loses the tax revenue and the subsidy that the state gets is anywhere from 50% to 60% of what it costs Uncle Sam," he said.
"Let's do it the other way. You figure out how much money you want to give out as a subsidy, you allocate it to the states, and then you have the state politicians or decision makers decide which infrastructure project should get subsidized."
Muni advocates prefer to tinker with the status quo as opposed to erasing the chalkboard and starting over.
"The federal tax exemption for municipal bonds is a centuries old partnership that has worked effectively and efficiently throughout its history," said Brett Bolton, vice president of federal legislative and regulatory policy for the Bond Dealers of America.
"This example of fiscal federalism has provided state and local governments the means to provide their citizenry with infrastructure and services as deemed necessary at the local level where these decisions are best made."
Lissack's book retreads the notion that tax exempt municipal bonds are a financial instrument enjoyed by the rich.
"The structure of the tax exemption provides disproportionate benefits to investors in the highest tax brackets," he wrote.
"The concentration of municipal bond ownership among high income households means that the tax expenditure associated with the exemption is highly regressive."
The Securities Industries and Financial Markets Association has numbers that point to a different conclusion.
"Most tax-exempt bonds are purchased and held by individuals who, whether they are saving for retirement or are already retired, rely on municipal bonds as part of a balanced and secure investment portfolio," said Leslie Norwood, managing director and associate general counsel, head of municipal securities, SIFMA.
"At the end of 2016, of the more than $3.8 trillion of tax-exempt bonds outstanding, 74% were held by individuals through direct investments and indirectly through mutual funds, money market funds, state and local government retirement plans, and related holdings."
One of Lissack's key recommendations involves creating direct subsidy bonds modeled on taxable Build America Bonds issued between 2009-2010 that offered subsidies to issuers to offset the tax burden.
Per the book, "The BABs program demonstrated the potential advantages of a direct subsidy approach. By making the bonds taxable and providing a direct federal subsidy to the issuer, BABs eliminated the leakage of benefits to high-income investors and expanded the potential investor base."
"This resulted in more efficient pricing and potentially lower net borrowing costs for municipal issuers."
BABs became problematic for many issuers when a subsequent budget sequestration began eating away at the formerly agreed upon subsidy.
"The BABs program provides an example of the potential financial risk to an issuer of relying on a federal program when financing a 10-, 20- or 30-year capital project," said Luby.
"Forcing the use of hard dollars by Congress also imposes the likely cost of borrowing onto all taxpayers, unless future Congresses actually commit to balanced budgets, as all municipal bond issuers already do."
