April 25 State and local groups descended on a
U.S. Senate hearing on Wednesday to defend tax exemptions on
municipal bonds, as a powerful Senator suggested an overhaul of
the tax breaks to benefit a wider range of investors.
The long-standing practice of exempting interest payments
allows states, local governments and authorities to offer lower
interest rates than they would on taxable bonds.
Because of the country's graduated tax system, different
bond buyers reap different tax benefits, with those who earn the
most getting the best break. Senator Max Baucus told a hearing
of the finance committee that he chairs that he was interested
in alternatives that would benefit more taxpayers.
"For every dollar we spend on infrastructure through a tax
exempt bond, twenty cents goes to tax breaks for higher-income
taxpayers," said Senator Max Baucus, chairman of the finance
committee. "A uniform subsidy would mean each taxpayer receives
the same subsidy regardless of tax bracket."
Groups representing cities and states did not speak at the
committee's hearing on coordinating state and federal tax codes.
They did, however, send letters and submit written testimony to
make the case for allowing investors to continue exempting
interest paid by municipal bonds from their taxes.
"Without access to this type of financing, the cost to
taxpayers for providing schools, libraries, public buildings and
hospitals, roads and bridges and sewers and waterways would be
much greater," wrote a coalition of civic groups that included
the National League of Cities.
Baucus, though, lauded the Build America Bond program as a
model for financing. Municipal bond issuers widely embraced the
program during its two years, rushing to sell the taxable bonds
that paid them direct federal rebates.
For years, lawmakers have complained about the inefficiency
of tax exemptions. But the idea of changing the tax code to
lower the amount of exemptions gained momentum last year when
President Barack Obama proposed limiting what high earners could
exclude in calculating their income taxes, including the
interest paid on municipal debt.
The proposal did not make it out of the Senate, but since
then the $3.7 trillion municipal bond market has been on watch.
In February, Obama suggested in his fiscal 2013 budget
cutting tax breaks for families with incomes over $250,000 by
only allowing them to reduce their tax liabilities to 28 percent
of income from the current 35 percent.
That attempt, too, will likely not make much progress.
Members of Congress and the administration have turned their
attention to legislation that appeals more to voters as they
draw nearer to the November general election.
Critics of the Obama proposal say it will force issuers to
offer higher gross yields.
Senator Orrin Hatch, the most powerful Republican on the
committee, summed up the position by asking the hearing
witnesses, who were primarily tax and accounting experts, "Does
everyone on this panel agree with me that the president's
proposal would raise borrowing costs for state and local
But Frank Sammartino, assistant director for tax analysis at
the Congressional Budget Office, which assesses the financial
effects of proposed legislation, did not agree.
"It might just have a minor effect on borrowing costs," he
said. The changes would would not affect tax payers below a 28
percent tax rate, he said and "taxpayers above that, would still
be better off buying tax-exempt bonds," over taxable ones.
He cited one study that estimated ditching the tax exemption
would only hurt those with the top 1 percent of incomes.
Sammartino, too, said the direct-pay model used in Build
America Bonds "is a more cost-effective way to provide a federal
subsidy," adding that in tax-exempt financing "the loss of
federal receipts is greater than the reduction in interest costs
for the issuers."
Sammartino suggested, though, a federal rebate equal to 15
percent of interest costs for direct-pay bonds, compared to the
much steeper 35 percent that Build America Bonds paid. By
switching to that model from tax-exempt financing, the federal
government would shrink its budget deficit by $30.5 billion from
2012 to 2016 and by $142.7 billion from 2012 to 2021, he added.
Still, attempts to bring back the direct-pay model have
stalled in Congress and issuers have balked at proposals that
would put the subsidy at less than 28 percent of interest costs.