Muni Bond Tax Exemption Repeal Could Spike Borrowing Costs by 50%

Total borrowing costs for cities, counties and states could increase by more than 50 percent if the tax-exempt status of municipal bonds is repealed as part of the ongoing budget talks on Capitol Hill, a new report has found.
by | February 28, 2013

Total borrowing costs for cities, counties and states could increase by more than 50 percent if the tax-exempt status of municipal bonds is repealed as part of the ongoing budget talks on Capitol Hill, a new report has found.

Interest costs in 2012 alone would have increased by nearly $54 billion to $154 billion if those muni bonds issued had been taxed by the federal government, according to the report, “Protecting Bonds to Save Infrastructure and Jobs,” which was released Wednesday and was a joint effort by the National Association of Counties, the National League of Cities and the U.S. Conference of Mayors. Over the past decade, the report said, state and local governments financed over $1.65 trillion of infrastructure investment using tax-exempt bonds.

The report comes as state and local officials are stepping up efforts to convince national leaders that the tax-exempt status of municipal bonds is a bigger win for local jobs and the middle class than it is for some of the wealthy individuals who may invest in the bonds.

“I don’t believe we have made [that argument] tangible to individuals,” said Houston City Controller Ronald Green during a press conference following the report’s release in Washington, D.C. He added that much of the information about the muni bond debate has revolved around the math: Will Congress fully eliminate the tax-exempt status or include it in an overall 28 percent cap on deductions by wealthy individuals?

“All of that means nothing unless you drive it down to who benefits from this,” said Green, who is also a member of the NLC. “While you may have people in upper level in tax brackets who invest in those bonds, the people who actually get the jobs from that are those people who live ... in the 19,000 cities we represent.”

According to the report, 90 percent of muni bond financing over the past decade nationwide went toward schools, hospitals, water infrastructure, sewer facilities, public power utilities, roads and mass transit. Schools received the biggest share, with more than $514 billion in bonds issued. Hospitals came in second with nearly $288 billion in bond financing.

If the tax-exempt status of municipal bonds were removed, issuers would have to increase the rate of return on those bonds to still make it worth investors’ while. That means it would cost more to borrow the same amount, which municipalities say would lead to less borrowing and fewer infrastructure projects.

“If we’re building less … you have fewer construction jobs, you have less economic opportunity,” said Mesa, Ariz., Mayor Scott Smith. “This kind of action -- while it appears that it solves Washington’s problem -- has a ripple effect that is beyond significance.”

The tax exemption comes at a cost of about $40 billion annually in lost revenue to the U.S. Treasury, according to some estimates, and for two years Capitol Hill lawmakers on both sides of the aisle have talked about changing that status as part of the national budget and spending debate.

Although the bonds were not affected by the January fiscal cliff deal, Smith said the continued budget debate on Capitol Hill has created a “new sense of urgency” as key deadlines approach beginning in March. “We see this as one of the options that’s still on the table that hasn’t been eliminated [and] I think people are more willing to listen now,” Smith said. “I think they talked about it but no one took it seriously. … And we need to let people know, what does it really mean?”

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