WASHINGTON Aug 19 Congressional lawmakers
working on comprehensive tax reform could harm U.S. cities,
states and other governments that sell municipal debt and damage
their credit quality, Standard & Poor's Ratings Service said on
Eliminating the tax exemption for interest paid by municipal
bonds, or simply changing the exemption, could reduce market
access and raise borrowing costs for issuers, which in turn
would have negative credit implications, the rating agency said.
Also, cutbacks to deductions for mortgage interest or state
and local property taxes could hurt smaller issuers, it added.
The chairmen of the major tax-writing committees - Senator
Max Baucus, a Democrat who heads the Finance Committee, and
Representative Dave Camp, a Republican who leads the Ways and
Means Committee - are expected to unveil a revamp of the tax
code when Congress returns from its August recess.
The chief concern in the $3.7 trillion municipal bond market
is that they will cut the value of tax breaks for those earning
more than $200,000 a year to 28 percent from the current 35
percent. If approved, the cap would essentially drive down the
appeal of municipal bonds, which are often sold to wealthy
investors willing to accept lower interest rates because of the
The market fears Congress could go one step further and
eliminate the exemption altogether.
"Without the tax exemption, municipal borrowers would face
higher interest rates with the inevitable result that many state
and local governments would need to impose higher taxes, do less
capital investment, or some combination of both," S&P said. "If
ending the federal tax exemption leads to higher state and local
taxes, low-income taxpayers could see their tax bills go up."
Larger issuers may be able to weather changes to the
municipal bond exemption because they have the resources to
appeal to investors, such as big pension funds, which would buy
debt with higher interest rates, S&P said. Smaller issuers,
though, would likely struggle to attract those buyers.
For many issuers, the higher interest rates accompanying a
cap on the exemption would force them to choose "between capital
investment, reserve maintenance, taxation and user fee levels,
and key services," ultimately resulting in lower infrastructure
Changes to the mortgage interest and local tax deductions
"would undercut demand for housing and weaken the prospects for
new housing development," it said, as well as risk lowering
local tax revenue.
"Any drag on residential purchases - or on the housing
market in general - would dampen the rate of economic expansion
to some degree. The only debate is by how much," S&P said. "We
believe that in aggregate, the contractionary consequences would
hit the labor market and retail sales hard."
Property taxes are the primary revenue source for most local
governments. If home buyers scale back their purchases because
of a smaller mortgage tax break, they would end up paying less
in property taxes, S&P said. At the same time, they could pare
back purchases of durable goods, which would drag down sales