Municipal issuers, dealer firms, and advisors are concerned about relentless efforts to eliminate the tax-exempt status of municipal bonds to pay for budget deficits.     

A recent report published by the American Enterprise Institute makes a case for keeping the 2017 Tax Cuts and Jobs Act permanent while adding in some extra provisions in order to boost economic growth, including the elimination of the tax-exempt status for municipal bonds. The suggestion is striking a resounding chord in the muni world. 

“That made my blood pressure go up,” said Emily Brock, director of the Federal Liaison Center at the Government Finance Officers Association. “It always feels like we have to defend the tax-exemption. There are real practical things that the tax-exemption does that helps to maintain our universe.”  

“This is not the first and it will not likely be the last time a tax reform proposal includes a tax policy change that could impact the municipal bond tax-exemption,” said Tom Kozlik, head of public policy and municipal strategy Hilltop Securities. 

Hilltop Securities

The comments came during a panel discussion at the Council of Development Finance Agency’s Federal Policy Conference being held this week in Washington D.C.  

The report was issued last week and offers two options for “enhancing” the TCJA legislation including an “aggressive” list that includes new ways of treating the taxing of interest income.  

Per the report, “interest income would be treated as qualified income like long-term capital gains and qualified dividends and face a top tax rate of 23.8%. In line with limiting the SALT deduction, this option also would eliminate the tax-exemption for municipal and other tax-exempt bond interest. The current exemption for municipal bonds provides an inefficient subsidy for state and local government infrastructure projects.” 

The report is authored by Kyle Pomerleau, a senior fellow at AEI, and Donald Schneider, deputy head of U.S. Policy at Piper Sandler. Schneider previously was the chief economist of the House Ways and Means Committee advising the Chairman on economic issues and tax policy. 

Several muni market advocates are beyond skeptical about some of the report’s conclusions. “The AEI report, while not a surprise, is misguided,” said Brett Bolton, SVP for research and public policy, Bond Dealers of America. 

“The report relies on the stale argument that the tax-exemption is inefficient without any real data to back up the position.  The report also refers to the need to increase competitiveness but fails to note that by sidelining the tax-exemption to pay for extension of the tax cuts, the proposal would kneecap state and local governments abilities to provide basic infrastructure.”  

The Biden Administration has emerged as a champion in infrastructure spending, but for two years in a row has omitted tax-exempt munis from the Treasury Department’s Green Book, which lists the administration’s explanation of tax proposals.  

As the federal government continues to rack up more debt, industry leaders are worried that attaching a tax to munis will become low hanging fruit as a pay-for. 

“This is not the first and it will not likely be the last time a tax reform proposal includes a tax policy change that could impact the municipal bond tax exemption,” said Tom Kozlik, head of public policy and municipal strategy Hilltop Securities. 

“This threat will likely increase in coming years as more analysis considering deficit reduction measures and other policy specifics like this one which is arguing in support of maintaining policy from the TCJA.”  

Kozlik also points to effects on the market. “The tax-exempt status is one of the things that certain investors very much find appealing. It’d also be more expensive for issuers to the tune of at least 10% to 20%.”  

Many of the existing provisions of the TCJA remain as thorns in the side of the muni world including the elimination of advance refunding and the cap on state and local tax deductions. 

The legislation is due to sunset at the end of 2025 as proponents and detractors gear up for what promises to be a bruising congressional session which is dependent on this year’s elections.    

Educating new members of Congress while shoring up support for the muni industry on Capitol Hill is a constant process. 

“Seventy percent of the Ways and Means Committee that voted for the (2017) tax package is gone,” Brock said. “That’s the members themselves, so their staff is totally new too. It’s going to take a whole new conversation with each committee and of course, what matters is who has the gavel on both sides.” 

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