Lawmakers on Capitol Hill this week will examine the tax-exempt status of municipal bonds, and whether states and localities should be able to continue issuing bonds tax-free. House Ways and Means Committee Chairman Rep. Dave Camp is moving ahead with plans to push a broad tax reform package with a hearing scheduled Tuesday on Capitol Hill that will look at the impact of tax exemptions and deductions on states and localities.
States and localities say that eliminating the tax-free status of the bonds would increase their borrowing costs and cut the number of infrastructure investments they can pay for.
The bonds' tax-free status was on the chopping block during Congress' fiscal cliff talks at the end of last year, but they ultimately were left untouched in the final deal reached in early January. Experts say they doubt Congress will actually change the bonds’ status, but municipal leaders undoubtedly will continue their lobbying effort as long as the bonds are part of the tax reform discussion.
Taxing muni bonds would add billions of dollars of new revenue to the national government -- as much as $40 billion annually, according to some estimates. That's why the notion is so attractive to some lawmakers in Congress. “As long as you’re trying to modify the tax code to generate more tax revenue, you’re going to look at larger tax expenditure items,” said Chris Mauro, director of Municipal Bond Research for RBC Capital Markets.
For his part, Camp has said his comprehensive tax reform plan won't be used to generate more tax revenue, although that sentiment is at odds with President Barack Obama’s goal of reforming the tax code in order to help raise revenues. Camp has said he's more interested in simply streamlining the naiton's tax code. He hasn't specified publicly which tax breaks and deductions might be touched, but he has said that nothing is off-limits.
Tuesday’s 10 a.m. hearing will also focus on other issues affecting local governments, such as pensions, retirement provisions and payroll taxes. Lawmakers also are slated to discuss the Pease provision, which places limits on itemized deductions (including the charitable deduction) on incomes above a certain threshold. That provision was created in 1990 but was phased out by the Bush tax cuts between 2006 and 2010; it was reinstated early this year as part of the fiscal cliff deal in Congress.
If municipal bonds are effected by tax reform, it likely will be in the form of nixing the tax exemption for industrial development bonds and private activity bonds, Mauro said. Those bonds, issued on behalf of private developers, make up a small percentage of the overall bond market and are often used in special cases such as post-disaster reconstruction.
Mauro said that the amount of time lawmakers are spending on reform works in the municipal bond industry’s favor. “Our view is that the longer this takes the better it is for munis, because all these interest groups can start making their case and put forward their positions as to how important the municipal exemption is to them.”