Hands Off Munis for Revenue! Hands Off Munis for Revenue!

Forbes: Hands  Off Munis for Revenue!  Group Rallies Against Tinkering With Tax-Exempt Status Of Debt

Authored by: Tedre DeSue

If an organized group of municipal bond players has its way, plans to cap or do away with the tax-exempt status of municipal bonds won’t come to fruition.

The coalition, called Municipal Bonds for America, is a virtual who’s who among muni bond players. Members represent just about every aspect of the roughly $4 trillion industry, as the group includes dealers, issuers and local leaders. Marc Jahr of the New York City Housing Development Corporation chairs the coalition and it is vice chaired by Marc Gerken of American Municipal Power. Citigroup’s chief municipal strategist George Friedland chairs the technical advisory committee for the coalition. The group’s main mission is to convey to politicians the importance of the industry and the dire consequences that could result from tampering with its tax-exempt status.

Even with all of this strong representation, the group has its work cut out for it. It is going up against a president who seems unstoppable in getting through tax law changes that place more of the tax burden on the country’s wealthiest taxpayers. It’s no secret that municipal bond buyers fall in this group of the wealthy, so it should be of little surprise that the tax-exempt status they enjoy on their municipal investments will continue to be a target, especially under this administration.

If President Obama formally puts proposals on the table to limit the value of the municipal tax exemption, it wouldn’t be the first time he’s done so. It would be his third. Limiting or doing away with the tax-exempt status was a cornerstone of Obama’s American Jobs Act of 2011. He failed to get lawmakers to pass it.

To the dismay of many, Obama, just months later, included a similar provision in his fiscal 2013 budget proposal. Needing a way to pay for a myriad of spending measures, Obama employed the same logic he used during the fiscal cliff debate – tax the wealthy more, the group that can most afford it. Opponents continue to stress that kind of mentality is irresponsible if no meaningful spending cuts are made.

These previous attempts to go after the muni bond tax-exemption so far have not paid off, and muni bond investors have been able to breathe a sigh of relief. However, they may not be that fortunate this time.

While the fiscal cliff legislation Obama signed at the beginning of the year leaves intact the tax exemption for municipal bonds, the issue is not settled. Mike Nicholas, the CEO of Bond Dealers of America and an organizer of the Municipal Bonds for America coalition, notes that the Obama administration and Congress are desperate to find more revenue as the country faces the dire ramifications of reaching its debt limit and not being able to pay its bills. These ramifications include a systematic shut down of government agencies, suspension of services and a possible downgrade of the country’s bond rating.

Municipal Bonds for America does not feign to not understand the dire straits of the country’s fiscal situation. However, its members, like many observers of the tax and spend debate, say the revenues raised from limiting the deduction would pale in comparison to the financial pain such a measure would inflict.

There are some muni bond basics that are being overlooked, Nicolas says. He points out that contrary to the belief that the tax exemption largely benefits the most affluent investors, most of the benefit is passed along to state and local governments. State and local governments are at very fragile financial crossroads in trying to finance capital projects on the heels of the recession. Measures that increase local borrowing costs will likely be frowned upon by the financial markets.

Columbia, S.C.’s Mayor Steve Benjamin says the elimination of the tax-exemption for munis would cause his city’s borrowing costs to rise to 300 basis points from 50 basis points.

State and local governments could be forced to cut back on crucial projects, such as those for roads, schools and water and sewer systems. If they pursue them, they will likely turn to taxpayers to pick up the costs to cover the higher debt service payments the issuers will have to pay.

Indeed, any plan to tinker with the tax-exempt status for munis creates a double-edge sword situation. One idea being bandied about entails replacing the tax exclusion for interest on state and local bonds with a direct subsidy to the issuer of 15% for the interest paid on those bonds. Total government savings could reach $200 billion over the decade under this plan. On that same note, the very people who are being targeted for their muni holdings will invest their money elsewhere. Interest paid on munis is minimal when compared to other investment vehicles. The incentive to buy munis, especially for those who live in states with high income tax brackets, would disappear. The demand for municipal bonds would diminish, making it more difficult for municipalities to fund their operations.

In December, when chatter heated up again about reducing the tax benefit of munis, there was a large move to the downside in muni bond ETFs. That included  iShares S&P National AMT-Free Municipal Bond Fund (NYSEArca: MUB) and the Market Vectors High Yield Municipal Index (NYSEArca: HYD). I suspect there will be similar negative moves in the coming weeks if lawmakers and Obama again go after munis to shore up the country’s financials.

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