Here is a good summary (produced by Wells Fargo) of the House Ways and Means Committee hearing about municipal bonds. The arguments for making munis taxable were that they were inefficient and costly state/local subsidies. The arguments for keeping the bonds tax exempt were that they were essential for building infrastructure and that the lower interest costs were passed on to all voters via lower taxes.
Bottom line, Republicans will accept fewer tax expenditures (including the elimination or reduction of muni exemption) in exchange for lower over all tax rates. Democrats, on the other hand, will not accept lower tax rates so when all is said and done the most probable scenario for munis ......is no change.
Wells Fargo Publication
"House Ways and Means Committee Hearing on State and Local Government Tax Reform Issues
Today the House Committee on Ways and Means held a hearing on Tax Reform and Tax Provisions Affecting State and Local Governments, focused on the exemption of interest on municipal bonds, and the deductibility of state and local government taxes. Witnesses included Scott Hodge of the Tax Foundation; David Parkhurst of the National Governors Association (NGA); Christopher Taylor, former MSRB Executive Director; and John Buckley, currently a Georgetown University Law Professor and former Chief Tax Counsel for the House Committee on Ways and Means. This memo provides a few highlights of the well-attended hearing. A copy of BDA's testimony, submitted for the record, is available [here].
Chairman Dave Camp (R-MI) indicated that his intention is to examine modifications to municipal bond tax exemption and deductibility of state and local taxes -- but only within the context of tax reform that would bring individual and corporate rates down to 25%.
Scott Hodge of the Tax Foundation staked ground far from center with continued pronouncements that tax exempt bonds should be eliminated entirely to reduce state and local government "overspending." He also said that state and local debt is increasing with no additional infrastructure investment (presumeably, describing refundings) and that the "cheap financing" associated with tax exempt bonds created a "moral hazard" for state and local governments. Moreover, he asserted that the states that benefit the most from the taxes-paid deduction also have the highest state and local income tax rates and are the wealthiest states, and both the state and local tax deductibility and tax exemption on municipal bonds lead to overspending, overtaxation, and overborrowing.
Ranking Member Sander Levin (D-MI) and Rep. Charles Rangel (D-NY) took Mr. Hodge to task over the notion that states that benefit the most from tax deductions overspend and overtax, suggesting that urban centers inherently carry higher infrastructure costs than rural areas and that in many states with higher taxes, investment of those taxes is in education, health care and other key priorities. Rep. Rangel pointed out that New York's tax base is actually a major contributor to the federal government's coffers.
As a former Mayor, Rep. Tom Reed (R-NY) asked Mr. Hodge how a local official would be able to finance infrastructure needs relying solely on tax revenues, and how capital could be leveraged and long-term assets could be financed under the scenarios Mr. Hodge outlined. Mr. Hodge said state and local governments should be permitted to borrow long-term, but should pay the same interest rate as private investors.
Rep. Sam Johnson (R-TX) asked Mr. Hodge how he would be able to respond to the City of Dallas, which has explained to him that removing the tax exemption for municipal bonds would raise costs and disproportionately impact citizens through increased taxes and fees. Mr. Hodge said eliminating the exemption might just encourage the city of Dallas to reduce borrowing, and it would be cheaper just to "give cash to the city" than to keep the current system of tax-exempt bonds in place.
Rep. Marchant (R-TX) joined his colleague in highlighting the fact that municipal bonds are an important catalyst for decisions at the local level.
David Parkhurst of the NGA pushed back on recent Congressional and White House proposals to eliminate or limit the municipal bond interest exemption. He highlighted the cost increases that would be passed on to state and local governments and create a backlog of infrastructure needs. He also asserted that tax-credit or direct-pay bonds should not be seen as a substitute for tax-exempt bonds.
Christopher Taylor (former MSRB Executive Director) highlighted broker-dealer industry scandals such as arbitrage and yield-burning as a cautionary tale in order to suggest that the committee be mindful of improving the integrity of the bond market that has produced infrastructure that is envied worldwide. During the Q&A period, Rep. Jim McDermott (R-WA) pushed back on the testimony, suggesting that while there have been abuses, they need to be considered in the context of percentages within the industry.
Mr. Buckley of Georgetown Law suggested that the exemption on municipal bonds and deductibility of state and local taxes are primarily on the table due to revenue concerns, and secondarily out of a desire of some to shrink government. He said that the perception that the municipal bond interest exclusion is only for upper-income investors is incorrect because it ignores the implicit tax borne by the investors in the form of a lower interest rate, and that the burden from repeal would be borne by state and local governments and their taxpayers. He said that the only economic benefit that can come from repealing the exemption is less infrastructure for the country, and if infrastructure is not to be financed with tax exempt bonds, another way must be found.
Responding to a question from Chairman Camp about private activity bonds as they were negatively portrayed in the recent New York Times article, Mr. Taylor suggested that the exemption should be only for truly public purposes and not private beneficiaries.
Mr. Buckley (and Mr. Parkhurst) explained to the Committee that many of the projects with private beneficiaries highlighted in the New York Times article were the result of disaster relief programs that have expired and are not generally the result of qualified private activity bonds purposes. He cautioned that while some tightening of private activity bonds rules may occur, the New York Times story anecdotes should not be used to justify repeal of a provision that has been proven effective.
On the topic of alternatives to tax-exempt bonds, Mr. Buckley said that Build America Bonds or other models should be a complement to tax-exempt financing.
Rep. Neal (D-MA) highlighted the recent National League of Cities/US Conference of Mayors/National Assocation of Counties study that demonstrates how much state and local government borrowing costs would rise if the exemption on municipal bonds were to be capped.
Rep. Paulsen (R-MN) asked Mr. Parkhurst about the uncertainty created by the President's proposal to cap at 28% the value of the municipal tax exemption. Mr. Parkhurst responded that such a cap would have an impact of 60 basis points or more and would inject significant uncertainty into the market.
The next steps for the Committee on Ways and Means will be additional tax reform hearings, and a report from the Joint Committee on Taxation (due in May) that will reveal the findings of tax reform working groups that have formed within the Committee. We will keep you informed of the Committee's progress on tax reform, and hope this information is helpful. Feel free to contact us with any questions.
Susan Collet at scollet@bdamerica.org
Jessica Giroux at jgiroux@bdamerica.org"