The Week in Public Finance: Tax Reform Fast-Tracked, Puerto Rico's Cleanup Mishap and the Pension Penalty
A roundup of money (and other) news governments can use.
RIP, State and Local Tax Deduction?
The federal perk that allows people to deduct their state and local taxes from their total income was put on the chopping block this week after the House narrowly approved a budget resolution that would fast-track major tax revisions. Nixing the deduction is a key part of the Trump tax reform proposal as it would pay for more than $1 trillion in tax cuts over 10 years.
The deduction is sure to be a focal point of debate in crafting a new tax bill in the coming weeks as a fair number of Republicans have said they want to keep it. In Thursday’s House vote, 20 Republicans -- along with every Democrat -- voted against the resolution.
The Takeaway: Opponents of the proposal to remove the deduction -- which include every major government association -- say eliminating the perk would be a huge blow to the middle class, particularly for homeowners who could no longer deduct their local real estate taxes. According to a study by the Government Finance Officers Association, more than one-third of deductions are for property taxes -- the majority of those taken by filers earning less than $100,000 a year.
They also argue that eliminating the deduction would amount to double taxation. Proponents of the proposal counter that the deduction subsidizes high-tax states while benefitting the rich the most.
In some ways, both sides are right.
According to the Urban Institute’s Tax Policy Center, 90 percent of the tax increase from eliminating the deduction would be paid by people earning more than $100,000 a year. Many of those taxpayers live in high-tax states like California, Connecticut, Maryland, New Jersey and New York.
However, it isn't true to say that the deduction means lower-tax states are subsidizing higher-tax states. Many of these high-tax states are also the least dependent on the federal government. Low-tax Alabama, for example, received $1.66 for every $1 it sent to the federal government in 2005, according to a study by the Tax Foundation. Connecticut, on the other hand, received just 69 cents for every $1 it sent.
Heard of Whitefish Energy? Neither Had We.
The first of many contracts has been awarded for Puerto Rico’s massive hurricane cleanup and restoration -- and it’s causing quite the controversy.
A small, Montana-based firm was given a $300 million contract from the government’s power utility, PREPA, to help get the island back on the grid. While this all seems routine -- especially since 80 percent of the island is still without power -- there are a couple big reasons why it's not.
For starters, utilities commonly deal with power restoration via mutual aid, where utilities in other states provide assistance to restore the affected region. In the days after Hurricane Maria, PREPA reportedly skipped that option and instead contracted with Whitefish Energy. Second, the contract was awarded in a no-bid process. PREPA officials have attributed that to convenience: Whitefish already had people on the ground because it had responded to a request for transmission repairs following Hurricane Irma, which hit the island nearly two weeks before Hurricane Maria.
The news has some members of Congress, which just approved a $36.5 billion natural disaster aid package, raising questions. Some are pointing to a very loose connection to the Trump administration -- the company is based in Interior Secretary Ryan Zinke's hometown -- as reason alone to question the lucrative deal.
The Takeaway: Puerto Rico is bankrupt, so it doesn’t have the best track record when it comes to spending money wisely. And by dealing with its first major contract in this manner, it just gave the federal government every reason to try to micromanage how it handles its rebuilding.
This also means that the commonwealth’s debt restructuring process could take a back seat for a time. As municipal analyst Matt Fabian notes, the island remains unable to collect most tax revenues and will likely need recurring injections of federal cash over at least the next year. “At some point,” he says, “federal loan repayments are likely to subordinate existing bondholders.”
As If an Underfunded Pension Wasn’t Bad Enough ...
Does your state or local government have a large unfunded pension liability? If so, it's paying a pension penalty in the bond market. That’s the finding from a study released this week by Boston College’s Center for Retirement Research.
The analysis compared the interest rates of governments with well-funded pensions to those of governments with poorly funded pensions. It found that the higher a state or local government’s unfunded pension liability was, the higher its borrowing costs.
That correlation is a post-recession phenomenon, according to the study. A previous analysis by the center did not find a statistically significant relationship between pension finances and borrowing costs.
The Takeaway: The main reason for this change is that most credit rating agencies have become more critical of underfunded pensions and have changed their ratings structures to incorporate pension funding. That’s resulted in more downgrades driven by the fiscal health of a government’s pension. Lower credit ratings translate to a higher borrowing cost.
So, what happens when governments pass pension reform? According to the study, not a whole lot. The researchers didn’t find a statistically significant correlation between pension reforms and reduced borrowing costs. This makes sense: Ratings agencies will often call pension reform a credit positive and even remove a government from its downgrade watch list. But a ratings upgrade only comes after actual -- not expected -- financial improvement.
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