Mayors and state officials are coming out hard against a proposal to change the tax exempt status of municipal bonds. The U.S. Conference of Mayors (USCM), The National League of Cities (NLC) and the National Association of Counties (NACo) issued a unified statement this week against the change saying it would threaten infrastructure projects already in the pipeline and future economic growth. During a roundtable at the National Press Club held for reporters by mayors, county and local leaders of all three non-partisan organizations released a report to highlight the broad use of municipal bonds in more than thirty locales around the country.
According to the report, State and local governments financed more than $1.65 trillion of infrastructure investment over the last decade (2003–2012) through the tax-exempt bond market. The bondholders of that $1.65 trillion reaped their return on investment without having to pay taxes on it. However, now that the federal government is looking for new revenue streams in the era of austerity, the Obama administration has proposed ending those exemptions.
“Municipal bonds are essential financing tools used by mayors and local officials in their communities,” said USCM Vice President Mesa, AZ Mayor Scott Smith. “Municipal bonds allow communities to build the streets, bridges, water lines, and police and fire stations that not only serve the needs of citizens, but also create jobs and drive the economy. Without them, our communities will suffer.”
The proposal is notable given the central role infrastructure investment has played in recent speeches and illustrations of the Presidents agenda for his second term. At the federal level infrastructure spending accounts for just 1.7%. The exemption has also been in place for 100 years, as long as the income tax. As CivSource has reported, this isn’t the first time these proposals have come up. Last year, the President considered a 28% cap on the tax benefit from municipal bonds.
Individuals are the largest holders of municipal bonds throughout the US and they represent one of the few consistent return streams for investors with a low risk tolerance. They are also one of the only ways municipalities have to fund infrastructure maintenance as well as new projects. Since 2008, demand on city services has only increased, and so have user fees as tax bases dwindle. Municipal bond issues often fill that gap, and forestall additional fee increases. Should those bonds become less attractive to investors and more expensive for cities to issue, the knock-on effects would be significant.
Market analysts have estimated that this proposed tax on municipal bond interest would raise state and local borrowing costs by up to 70 basis points (0.70 percentage point) or more. Because the tax would apply not only to new state and local borrowing, but also to all outstanding bonds, investors would be taxed on investment which they reasonably expected would be tax-exempt as long as they are outstanding — an unprecedented form of retroactive taxation.
Without the exemption cities could pay nearly 50% more on their bonds in addition to the hit investors would take. Looking across the spectrum of tax exemptions made to say, private entities, or specific tax brackets, the case that municipalities should face bigger hits to their budgets even while federal spending on cities continues to drop is a hard one to make.
“Our county has about $2.1 billion of general-obligation bonds outstanding at this time, on which we pay interest of $93 million a year. Eliminating or even capping the tax exemption on investors would cause them to look for higher-yielding investments and we would have to offer more interest to lure them back. This simply drives up the county cost to local taxpayers to maintain our infrastructure. [And] the burden will be transferred to the property tax,” said Tim Firestine, Chief Administrative Officer for Montgomery County, MD, President-elect of the Government Finance Officers Association and NACo representative.
The Obama Administration has proposed a national infrastructure bank and a new take on the Build America Bonds, called America Fast Forward, however the details of this plan are not all that clear. Specifically, where the funding is going to come from over the long term. Federal programs in this area don’t have a strong track record of success relative to the immediacy of municipal bond funded projects. The National League of Cities in their statement on the proposal, noted that federal bond programs have often been less popular as cities and investors alike find federal oversight less attractive.
“The White House announcement says The America Fast Forward bonds are modeled after the Build America Bonds program. This program, while successful, made up only a small portion of the total number of municipal bonds that were issued to support infrastructure development and repair. Build America Bonds was, and remains, no substitute for municipal bonds,” the organization said.