Hurricane Sandy could provide an unexpected boost to local governments and financial service firms that are trying to keep a proposal to tax municipal bond interest out of the debate over the fiscal cliff.
The Council of Development and Finance Agencies in Columbus, Ohio, is lobbying lawmakers from storm-ravaged areas to support a special allotment of “Hurricane Sandy Recovery Bonds” to rebuild damaged real estate, commercial waterfronts, power grids and other infrastructure. The effort would resemble the legislation Congress enacted in 2005 to allow Louisiana, Mississippi and Alabama to issue debt to rebuild areas damaged by Hurricane Katrina and may at least temporarily slow calls to levy new taxes on the $3 trillion muni market.
Interest earned on the bonds that municipalities float to finance roads, sewers and other public-works projects has been exempt from the federal tax for almost a century. But calls to revoke that status have intensified as lawmakers search for new sources of revenue to reduce the budget deficit.
“I think it’s a horrible idea for the fiscal cliff,” said Toby Rittner, the development council’s president and CEO. “It would be difficult for [a lawmaker] to go back to the district and explain why the cost of water, bridge or school projects is 30 percent higher because they voted for a short-term fix to address the budget deficit.”
The council and a coalition of local government and investment interests called Municipal Bonds for America say lifting or capping the tax exemption would make the bonds less attractive to investors and force issuers to make higher-interest payments to make up the difference. The added cost would trickle down to users of the projects in the form of higher tolls, parking charges or other user fees, the groups say.
Changing the bonds’ tax-exempt status yields “a nice, big number on the federal government’s balance sheet, but the tax consequence is the citizen is going to pay more,” said Lars Etzkorn, program director at the National League of Cities. “To some degree, it’s a shell game.”
Parties lobbying on the issue include the Bond Dealers of America, the National Association of Local Housing Finance Agencies, the Education Finance Council, and financial service firms such as Wells Fargo Advisors and Piper Jaffray.
Congress exempted municipal bond interest from federal income taxes in 1913. Lawmakers in 1986 limited the exemption to public-purpose bonds and subjected many bonds issued for private activities to the alternative minimum tax.
President Barack Obama’s fiscal 2013 budget plan proposed going further, by capping the exemption on public-purpose bond interest to 28 percent from the current 35 percent for individuals earning more than $200,000 a year and couples making more than $250,000 a year.
The National Commission on Fiscal Responsibility and Reform in 2010 proposed making interest taxable as income for newly issued bonds. And Sens. Ron Wyden, D-Ore., and Dan Coats, R-Ind., last year proposed eliminating the issuance of new tax-exempt bonds and instead offering tax credits equal to 25 percent of the interest paid.
Any such moves would deliver new revenue to the Treasury. The Joint Committee on Taxation last year estimated that lifting the bonds’ tax-exempt status completely would raise $124.4 billion over a decade.
Opponents say any such changes could drive up localities’ borrowing costs by 1 percent to 2 percent because issuers will need to pay more interest to compete with other taxable investments.
Rattner’s group says it also could cut off a potential source of low-interest financing for communities affected by last month’s superstorm.
Although the Federal Emergency Management Agency will cover some recovery costs, which could reach as much as $50 billion, the development council will press for expanded authority so states and localities can issue bonds for private activities.
If Congress doesn’t act, utilities such as Consolidated Edison could raise customer rates and agencies such as the New York Metropolitan Transportation Authority may issue their own bonds to help cover system repair bills.