Several market participants are forming a coalition to lobby for the retention of the tax-exempt status of municipal bonds.
The group, Municipal Bonds for America, is being spearheaded by the Bond Dealers of America, a collection of regional underwriters.
The coalition is bringing together underwriters and issuers, said Mike Nicholas, chief executive of the BDA.
Talk of tax reform, which is heating up during the presidential election season, was the impetus behind the formation of the group, he said.
The tax reform debate has focused on how to lower individual rates, perhaps by eliminating deductions such as the muni bond tax exemption.
“This is one of those tax expenditures ... that are very vulnerable,” said John Murphy, executive director of the National Association of Local Housing Finance Agencies, which represents entities in the affordable-housing market and is one of the founding members of Municipal Bonds for America.
Representatives from 17 bond underwriters and a few issuers are the initial members.
"AFFORDABLE HOUSING'
“As an issuer, we recognize the importance of this [tax exemption] issue,” said Marc Jahr, president of the New York City Housing Development Corp., which is a member of the NALHFA. “We can bring our experience and knowledge of this market to our representatives in Washington.”
Loss of the exemption “would seriously hurt our ability to create affordable housing,” Mr. Jahr said.
Mr. Nicholas' effort to build the coalition “is spot-on,” said Ronald Bernardi, chief executive of Bernardi Securities Inc., which underwrites munis and manages fixed-income portfolios.
Lawmakers need to hear from issuers about what tax-free bonds do for local communities, not just from bond dealers trying to protect their business, he said.
“The rub on the tax-free market is that it benefits the wealthy. Well, yes, it does,” Mr. Bernardi said.
“But you use tax expenditures to move public policy in the direction you want — to build nicer schools, park facilities and jails that benefit everyone. Those constituents need to be heard,” Mr. Bernardi said.
Proposals to end the muni tax exemption are nothing new, but members of the new coalition worry about what they see as a growing threat.
CAPPING THE VALUE
President Barack Obama has supported capping the value of the tax exemption at 28% for high earners and has proposed resurrecting the Build America Bonds program, under which municipalities issued taxable bonds and got federal subsidies to reduce interest costs.
In 2010, the president's budget reform commission, headed by Erskine Bowles, chief of staff under President Bill Clinton, and former Sen. Alan Simpson, R-Wyo., called for eliminating the exemption.
At the same time, Republican presidential candidate and former Massachusetts Gov. Mitt Romney has promised to end unspecified deductions to create funding space for lower tax rates. The muni bond tax exemption could well be one of the tax expenditures to hit the chopping block, as it is viewed as a loophole for the rich, compared with more-widely-used deductions such as home mortgage interest or employer-provided health care benefits.
Economists have argued that a direct subsidy to states and localities is more efficient than the outright tax exemption, which ends up benefiting underwriters and high-income investors, not just state and local governments.
“Even if you thought the federal government should subsidize [municipal borrowing], an exemption is an inefficient way to do it,” said Alan Viard, an economist and resident scholar at the American Enterprise Institute.
The Congressional Joint Committee on Taxation estimates the Treasury will lose out on $117 billion in tax revenue between 2011 and 2015 by not taxing public-purpose bonds.
But bond underwriters and some issuers don't want to risk giving up the exemption in exchange for the uncertainty of direct federal payments.
BUILD AMERICA BONDS
“State and local governments have never been big fans of [Build America Bonds],” Mr. Nicholas said. “Issuers are completely dependent on the federal government to make that payment.”
Those fears have been made more real with the threat of fiscal-cliff spending cuts, which would cut back on the subsidy for such bonds, he said.
“We have decades of experience with tax-free municipal bonds,” Mr. Jahr said. “You can make theoretical arguments against the efficiency of [the exemption], but it's worked very well [for] housing bonds.”
Going to a direct-subsidy model “would be a brave new world for us,” Mr. Jahr said.
Despite those fears, complete loss of the exemption is unlikely.
“In our view, there is too much support of the current exemptions to allow for drastic changes,” analysts at
BlackRock Inc. wrote in a recent report.
“Even if some sort of tax reform affecting muni bonds' status were implemented, it would almost certainly be phased in over a number of years [and] we see absolutely no chance of tax exemption being repealed retroactively,” the report said.
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