Tags: Deficit | Panel | End | Tax-Free | Muni | Bonds

Deficit Panel Would End Tax-Free Muni Bonds

Thursday, 02 Dec 2010 11:36 AM

A proposal by President Barack Obama's deficit commission to tax the interest paid on state and local government bonds drew criticism on Wednesday that it would raise costs for states — just as they're struggling with big budget gaps.

In its revised plan for balancing the U.S. budget released on Wednesday, the National Commission on Fiscal Responsibility and Reform suggested generating revenue by ending the income tax exemptions of interest on municipal bonds sold in the future.

"It will cost states a lot more to float bonds," said Raymond Scheppach, executive director of the National Governors Association, who said interest payments could jump by a third. "Given the whole fiscal situation, it would be tough."

On Wednesday, Scheppach's group said states are reporting $11 billion in budget gaps for the current fiscal year and $40.5 billion in deficits for next year, forcing economically struggling states to grasp for savings through spending cuts.

Obama established the 14-member deficit commission in February, and it is set to vote on its final recommendations to the U.S. Congress on Friday.

Currently, $2.8 trillion of debt is outstanding in the municipal market. Bond issuers say exemptions keep borrowing costs down and attract investors who will accept a lower interest payment if they know their interest income will not be subject to federal taxes.

"The tax exemption has been the foundation of state and local finance since the inception of the first Internal Revenue Code," said Michael Decker, managing director and co-head of the municipal division of the Securities Industry and Financial Markets Association.

When Congress considers the commission's recommendations, "they should recognize the important role tax-exempt bonds have played in the country's development," Decker added.

The cost of issuing debt could go up by about a third, said Utah State Treasurer Richard Ellis. "The tax exemption needs to remain in place," he said.

The small city of Carmel, Indiana, would likely cut back on the projects it finances if interest rates were higher, said its mayor, James Brainard.

"We'd build fewer roads. We'd build fewer water systems. We'd have fewer jobs," Brainard told Reuters, adding that the higher debt costs could also be passed onto taxpayers.

"Taxpayers are not looking for the federal government to reduce expenses and have local governments pick up those expenses," he said.

Last year, the Congressional Budget Office, a nonpartisan government research agency, said the federal government forgoes $26 billion annually by allowing interest payments on state and local debt to escape taxation.

If borrowing costs go up states will raise taxes or cut spending to pay off debt, said Jon Lawniczak, executive director of the National Association of State Treasurers.

Lawniczak added states do not tax interest paid on U.S. debt, and thereby subsidize federal operations.

"It's a two-way street," he said.

Over the last year and a half, Build America Bonds have thrown traditional borrowing methods into question.

The bonds, created in the federal economic stimulus plan, pay interest that is taxable. The U.S. government then gives issuers rebates equal to 35 percent of the interest costs.

Build America Bonds caught on like wildfire, now representing 26 percent of new municipal debt.

Part of their appeal has been the subsidy size, which the Obama administration says is so large that the bonds are not "revenue neutral," meaning taxes paid on the interest do not cover the subsidies. Ultimately, the government loses money.

Obama wants to make Build America Bonds permanent — the program expires with the stimulus plan this month — but lower the subsidy to 28 percent. The House of Representatives has twice passed a temporary extension with the subsidy rate of 30 percent. An extension has faltered in the Senate.

"They may extend that for a year, but in the long run they're not going to maintain it," said Scheppach about BABs.

© 2017 Thomson/Reuters. All rights reserved.

 
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A proposal by President Barack Obama's deficit commission to tax the interest paid on state and local government bonds drew criticism on Wednesday that it would raise costs for states just as they're struggling with big budget gaps. In its revised plan for balancing the...
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Thursday, 02 Dec 2010 11:36 AM
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