US municipal bond market braces for tax overhaul
WASHINGTON Aug 20 (Reuters) - Weeks before lawmakers unveil a proposed overhaul of the U.S. tax code, investors and firms tied to the municipal bond market are trying to head off their worst fear - caps or cuts to the tax exemption for interest on debt sold by cities, states and other government bodies.
Traders, issuers and investors say they may have to fight a two-front battle as the exemption could also be targeted during congressional negotiations expected next month on the federal debt ceiling.
The chief concern is that reform legislation would cut the value of tax breaks for high earners to 28 percent from the current 35 percent. That could drive down the appeal of municipal bonds, which are often sold to wealthy investors willing to accept lower interest rates because of the exemption.
Standard & Poor's Ratings Services released a report on Monday that said capping the exemption or eliminating it altogether in tax reform "would cause a significant disruption to the market and increase the cost of borrowing for municipal entities." Higher costs could have negative credit implications, it added.
Currently, the torch-bearers for tax reform - House of Representatives Ways and Means Committee Chairman Dave Camp, a Republican, and Senate Finance Committee Chairman Max Baucus, a Democrat - are meeting with constituencies during a Congressional break. They are expected to unveil a proposed rewrite of the tax code after the August recess.
While issuers have worried the tax break will be wiped out completely, no lawmaker is openly discussing that option.
In making its case, S&P pointed to Baltimore, a city that recently closed a $30 million budget gap. In fiscal 2012, the city would have paid more than that shortfall, $35 million, in additional interest if its outstanding debt was not tax-exempt, S&P said.
'CLEAN SLATE' APPROACH
Earlier in the summer, Baucus and Senator Orrin Hatch, the highest ranking Republican on the finance committee, solicited ideas from other senators in a "clean slate" approach to reform. Dealers, investors, traders and issuers flooded Capitol Hill with letters and meetings to make the case for the exemption.
It is difficult to gauge whether the push paid off, as most Congressional suggestions were not released. In one of a few letters publicly circulated, Senator Bernie Sanders, an independent from Vermont, wrote that keeping the exemption would help the country's "energy economy" and job growth. Municipal bonds primarily finance infrastructure, including utilities.
The exemption fits the criteria Baucus and Hatch have for reform because it is logical, helps create jobs and provides a general benefit to the country, said Mike Nicholas at Bond Dealers of America, adding that Democrats and Republicans in both chambers support the exemption.
In July, 183 House members sent a letter to their chamber's leadership saying a cap "would severely curtail state and local governments' ability to invest in themselves" and would "shift costs to local residents through tax or rate increases."
TAKING A SHORTER AND LONGER VIEW
The cap, though, could come up in other Washington dealings, namely negotiations to avoid a federal shutdown on Oct. 1.
As the country reaches its debt limit it will have to scrounge for billions of dollars, said Bill Daly, director of governmental affairs for the National Association of Bond Lawyers. Lawmakers will not have the time to take the same detailed, careful survey of options and look at "things even bond lawyers would consider down in the weeds," he said.
"You get a more broad-brushed approach, which is why I would think the 28 percent cap is very much in play. And that's what I think ought to be the more immediate concern than tax reform," he said.
The Congressional Budget Office estimates the U.S. government lost $30 billion due to the exemption in fiscal 2011. Obama has repeatedly included the cap in his budget proposals saying the cost of the exemption to the U.S. government outweighs benefits reaped by local governments.
In the autumn of 2012, Obama and Congress discussed limiting the exemption or ending it to raise revenues as the country faced a "fiscal cliff" of tax increases and spending cuts.
"Look, we're really right back in the same situation, just change the number on the fiscal year," said Dustin McDonald, director of federal liaison for the Government Finance Officers Association, adding the organization will "make the rounds and advocate for preservation of the exemption."
Then there is the prospect that tax reform could stretch out for years. Legislation could take until 2017 to work through Congress, creating openings for the cap to bubble back up, Nicholas said.
"That's why we're vigilant with multiple meetings every week," he said about conducting "Muni Bond 101" sessions with legislators and staffers. "We're not sitting back thinking this isn't going to happen until 2017. We're defending it every day."