When a century-old tool that funds roads, schools and hospitals is under assault, expect pushback.
That’s the message being sent by an uncommonly wide group of political leaders on proposals to limit or eliminate the exemption on municipal bonds.
The nation’s mayors, who face the unglamorous yet essential task of providing essential city services, said while there’s consensus in Washington on the importance of modernizing the nation’s infrastructure, various proposals threaten the key component that pays for it.
“The tax exemption on municipal bonds is the only thing we have left to meet the nation’s infrastructure needs,” Stephen Benjamin, mayor of Columbia, SC, said at a recent meeting of the U.S. Conference of Mayors.
“This is not dessert – this is bread and butter, and it’s important to us that we reaffirm our position that investment in our cities is non-negotiable.”
Wide support for municipal bond exemption, but resistance persists
As we’ve mentioned, (“The One Issue Politicians Aren’t Fighting About”), maintaining the exemption enjoys wide support, yet proposals to compromise it persist.
The Obama administration has, for several years, proposed limiting it, while House Speaker Paul Ryan’s outline on tax reform, which calls for limiting deductions, exclusions and credits in the tax code, is widely regarded as a threat to the exemption, too.
Benjamin noted from 2003-2012, state and local governments issued $1.65 trillion in tax-exempt bonds to help fund schools, hospitals and water and sewer improvements. If the exemption were capped at 28% during that time, he said, cities would face increased costs of $200 billion, and if it were completely eliminated, the figure would about double.
“For many of our cities and communities, it would effectively prohibit them from making necessary investments in infrastructure,” he said.
Senate moves to include munis as HQLA
Meantime, a bipartisan group of U.S. senators recently introduced a bill that would allow banks to include municipal bonds as “high quality liquid assets.” While a seemingly arcane rule, it’s important to both municipal bond investors and issuers.
Under Fed rules enacted after the fiscal emergency of 2008, large banks are required to hold enough liquid assets to fund their operations for a month if other sources of funding aren’t available. Though foreign sovereign debt securities were considered high quality under the rule, investment-grade munis weren’t and therefore couldn’t count toward satisfying the requirement.
Since large banks are significant muni bond investors, their participation in the market has helped maintain liquidity in the market.
After the rule was introduced in 2014, there was a bipartisan outcry. Earlier this year the House passed a bill that would treat munis as high quality under the rule. The Fed proposed amendments that would allow some munis to be treated as high quality, though other regulators failed to act.
“We must ensure a continued and reliable access to capital markets for our local governments, and this legislation represents a compromise that achieves that while appropriately balancing concerns for the long term stability of our financial system.” said Sen. Mark Warner (D-VA), a sponsor of the bill, along with another Democrat and a Republican.
The new rules are scheduled to go into effect next year. We hope – and expect – a consensus to emerge among regulators, Congress and the president to support a provision of the original tax code that has served the country well for 103 years.