By Lisa Lambert
WASHINGTON, April 10 President Barack Obama in
his budget on Wednesday revived a proposal to cap the value of
the tax exemption for interest paid on municipal bonds, an idea
that has rattled the $3.7 trillion municipal bond market for
more than a year.
Obama wants to limit the value of tax benefits for the top
earners. The budget would limit the tax rate at which
high-income taxpayers can reduce their tax liability to a
maximum of 28 percent, which would affect the top 3 percent of
households in 2014.
If approved, the cap would essentially drive down the appeal
of municipal bonds, which are often sold to wealthy investors
who are often willing to accept lower interest rates because of
the tax exemption. Diminished demand could in turn push up
borrowing costs for state and local governments that use the
bonds to finance bridges, roads and other capital projects.
A rise in interest rates "will increase the cost of projects
financed by municipal bonds as much as 20 percent or prevent
vital projects from moving forward," said Marc Jahr, president
of the New York City Housing Development Corporation and
chairman of the advocacy group Municipal Bonds for America.
Limiting the exemption would undermine infrastructure
investment and would risk raising taxes or fees, according to
Clarence Anthony, executive director of the National League of
"We remain frustrated the administration continues to view
limiting the exemption as a cost-saving measure, rather than
seeing it for what it really is -- a significant cost increase
for local governments and our residents," Anthony said in a
AMERICA FAST FORWARD
In his budget, Obama provided details on another idea that
has raised alarms about the future of the exemption: launching
taxable America Fast Forward Bonds to finance infrastructure.
When Obama first suggested the program in February, issuers
worried Fast Forward bonds would replace tax-exempt debt.
In the budget, Obama said the program "would be an optional
alternative to traditional tax-exempt bonds."
The bonds would be patterned after the 2009 economic
stimulus plan's Build America Bonds. When used to finance
education construction projects, they would pay issuers federal
rebates equal to half the interest costs. For other projects,
the rebate rate would be 28 percent.
But the education bonds could only be sold for two years and
not be used for refundings, while the lower-subsidy debt would
be used for longer and could be sold to refinance other bonds.
In recent years, new debt has been sold for schools at a
maximum of $59 billion per year, said Rich Ciccarone, a managing
director and the chief research officer at McDonnell Investment
Management. Issuers could sell the same amount of the education
bonds or more, given that the program is temporary and offers a
rich subsidy, putting the U.S. government on the hook for
billions of dollars for decades.
"We don't really look like we're budget cutting there. We
have a stimulus program going on," he said.
The budget is only a proposal and will likely not become
law, leaving Congress to approve separate legislation creating
the Fast Forward bonds. That could prove tricky since many
Republicans, who control the House of Representatives,
criticized BABs as rewarding profligate states.
"If you are a conservative state you are less likely to take
advantage of this as a borrower who is frequently in the
market," Ciccarone said. "Through the federal subsidy program
they would be paying tax dollars for other states' debt."
The Fast Forward bonds offer many benefits, including
making investments in infrastructure and creating jobs, and they
will likely expand the pool of bond buyers, said Vikram Rai,
analyst at Citigroup Global Markets.
But this winter BABs issuers got a cold shock when they
learned their rebate payments are subject to the spending cuts
known as sequestration. Issuers will be suspicious Fast Forward
bonds' rebates could be "exposed to shifting political
priorities," he said.
"Can we rely on our federal representatives to do what they
told cities, counties and school districts they would do? The
answer right now is 'no,'" the mayor of Columbia, South
Carolina, Steve Benjamin, said about BABs. "Until we can rely on
the promises of the federal government, any other model should
be a complementary tool."
With Obama's budget seemingly headed nowhere, the threat to
cap the exemption will likely remain just a threat for a while
as well. This is the third time Obama has suggested the cap, and
members of both parties in Congress have expressed opposition to
the limit, including heavy hitters such as Republican House
Majority Leader Eric Cantor and Democratic Senator Elizabeth
Warren of Massachusetts.
"It doesn't have a very high likelihood of coming to
fruition," said Peter Hayes, the head of BlackRock's municipal
Still, governors, mayors, and investors are on guard after
the cap came up during negotiations on the "fiscal cliff" last
year. A coalition of city and county leaders has estimated they
would have paid $18.8 billion more in interest over the last
decade under Obama's cap.
In fiscal year 2011, the U.S. government missed out on
collecting $30 billion in revenues because of the exemption,
according to the Congressional Budget Office.
According to Obama's estimates, the U.S. government lost out
on $29.3 billion in income tax revenue this fiscal year due to
the exclusion of interest on state and local bonds sold for
"public purposes," mostly general obligation debt. The foregone
amounts could total $202.69 billion over the next five years.