The muni bond tax-exemption has existed since the federal income tax was established in 1913, but if anyone in Washington is forgetting just how important it can be, the devastation wrought by Superstorm Sandy should be a poignant reminder.
With damages of approximately $62 billion, parts of New York, New Jersey, Connecticut and other states and municipalities face an enormous challenge cleaning up, rebuilding and working toward ameliorating the effects of future storms.
How will these efforts be funded?
A proposal known as the “Hurricane Sandy Recovery Bond” program is currently being circulated to lawmakers. Under the proposal, state and local governments, as well as private companies and non-profit groups, would have increased access to tax-exempt financing.
It’s an old idea for a new need. Similar programs were enacted by Congress following Hurricane Katrina and the 9/11 terrorist attacks.
Obvious, except for one thing
On the surface, the approach should be a no brainer. The storm was not only deadly and destructive, it was also far reaching, contributing to a decrease in U.S. consumer spending in October and November, according to the Commerce Department. Already facing lackluster growth in the country and tight state and local finances, the hurricane couldn’t have come at a worse time.
So what could possibly threaten this proven method for communities to quickly access funds and get back on their feet?
Enter politicians and the “fiscal cliff”
As we all know, there is heated debate in Washington over how to circumnavigate this potential peril. One of the targets in various proposals to reduce spending and increase revenue is the municipal bond tax exemption which some legislators see as simply a tax break for the wealthy.
We have seen proposals that would eliminate the tax-exemption on all new issues of munis (Simpson-Bowles); others would abolish the exemption for new private-activity bonds (Domenici-Rivlin). The president last year floated the idea of placing a 28% cap on the benefit to taxpayers of tax-free interest.
Bad time to cut a lifeline
Needless to say, we’re not thrilled with any of these proposals because they miss the most vital part of the equation.
Municipal bonds have helped finance trillions of dollars in public infrastructure for almost a century. Eliminating the tax exemption would raise borrowing costs for state and local governments by an estimated 200-300 basis points, while the administration’s proposal to cap the benefit of tax-exemption would raise borrowing costs by about 50-100 basis points.
As an investment vehicle, munis have not just been a boon to affluent investors, but many others as well; more than 50% of all municipal interest income is reported by taxpayers making less than $200,000.
As the true costs of Sandy continue to mount, and the potential consequences of other weather events come into sharper focus, there couldn’t be a worse time to tamper with a financial lifeline critical in rebuilding roads, bridges, rail lines, electrical grids and countless other public works projects.
Sandy had a devastating impact on its victims in the Northeast but, we believe there is credence in the old proverb “it’s an ill wind that blows nobody any good.” Hopefully this tragic event will open the eyes of our often myopic lawmakers and enlighten them to the side of the coin they are missing.