The Bond Buyer - - Front Page - BY JOHN HAL­LACY

for­ever changed if the tax re­form pack­age pro­posed in the House is adopted un­al­tered

The mu­nic­i­pal in­dus­try will be for­ever changed if the tax re­form pack­age pro­posed in the House is adopted un­al­tered. Of course, the prob­a­bil­ity of no al­ter­ations to Tax Cuts and Jobs Act H.R. 1 is quite re­mote. But the al­lot­ted com­pressed time­frame con­sid­ered for adop­tion means that the trade­offs will need to be de­ter­mined quite swiftly, with less con­tem­pla­tion and re­flec­tion.

Ad­min­is­tra­tion of­fi­cials had said the bill would pre­serve the mu­nic­i­pal tax ex­emp­tion, and thus leave the muni mar­ket un­touched. I do not call elim­i­nat­ing the tax ex­emp­tion for Pri­vate Ac­tiv­ity Bonds (PABs) leav­ing the mar­ket un­touched.

When bonds rep­re­sent­ing about 20% of the ex­ist­ing mar­ket are no longer el­i­gi­ble for tax ex­emp­tion by pro­posed leg­is­la­tion it is quite no­tice­able. We con­tinue to re­fine the per­cent­age but it is not avail­able in a dis­crete cat­e­gory in the ex­ist­ing clas­si­fi­ca­tions for debt out­stand­ing.

The other com­pli­cat­ing fac­tor is that the de­scrip­tion cuts across sec­tors. Hous­ing, health­care, and bonds across other sec­tors will be for­ever trans­formed.

If it were not for the fed­eral gov­ern­ment’s need to off­set the ef­fect of the tax cuts with other rev­enues and ex­pen­di­ture re­duc­tions, why would any­one want to cur­tail ad­vance re­fund­ings?

Ad­vance re­fund­ings have saved main­stream mu­nic­i­pal is­suers bil­lions in this cy­cle. Although cur­rent re­fund­ings will re­main an op­tion, the great­est amount of sav­ings has been ob­tained with ad­vance re­fund­ings.


The cat­e­gory in a “nor­mal” mar­ket typ­i­cally rep­re­sents about 25% to 35% of our to­tal an­nual vol­ume, not tak­ing into ac­count some of the re­cent peaks in re­fund­ing ac­tiv­ity. One of the pri­mary ra­tio­nales over the years for an in­vest­ment banker to visit an is­suer has been the premise of dis­cussing a re­fund­ing of higher coupon debt for real sav­ings in in­ter­est costs.

You will re­call that re­fund­ings used to be un­lim­ited and then were per­mit­ted only once. The in­ex­orable pro­gres­sion to zero has ar­rived. It would make sense for bonds out­stand­ing to have their one chance pre­served.

I have not met many pro­fes­sion­als in our business who are en­am­ored of tax credit bonds. Hav­ing said this bluntly, tax credit bonds have en­cour­aged is­suance in seg­ments where needs are great, in­clud­ing schools and en­ergy ef­fi­ciency just to name a cou­ple. Some in­ter­ested par­ties have even been dis­cussing bring­ing back some form of Build Amer­ica Bonds.

The ex­ist­ing sub­sidy had be­come trou­ble­some due to se­ques­tra­tion, but most con­sider the BABs pro­gram a re­sound­ing suc­cess even long after the pro­gram ceased. Tax­able buy­ers had a real op­por­tu­nity to get much more fa­mil­iar with the wide­spread sta­bil­ity that mu­nic­i­pals of­fer for the most part. Many in the buyer base con­sider that sta­bil­ity only sec­ond to the Trea­sury mar­ket.

Re­mov­ing the tax ex­emp­tion for sta­dium bonds has been in view for a very long time. Sen­a­tor Moyni­han was the first to raise the is­sue many years ago when he main­tained that new sta­di­ums were be­ing con­structed with tax­payer sub­si­dies while schools were crum­bling. Although many sports fans will lament the more mixed prospects for new sta­di­ums, some­how, we be­lieve the in­dus­try will find a way.

Many other pro­vi­sions in the bill will af­fect the mu­nic­i­pal in­dus­try in myr­iad ways.


The de­duc­tion for state and lo­cal taxes, or SALT, has been un­der as­sault. Lim­it­ing the prop­erty tax de­duc­tion to $10,000 per year will di­rectly af­fect many home­own­ers on both coasts. One does not con­sider the pur­chase of a home just based on the amount of prop­erty taxes due on that prop­erty.

On the other hand, many con­sider the pur­chase of a home based on the qual­ity of the lo­cal school dis­trict. Lo­cal schools are pri­mar­ily sup­ported by state aid and the prop­erty tax. Given that the real es­tate tax de­ductibil­ity would be trimmed, it may not be as easy to pass a school tax in­crease in the fu­ture. There is the tax con­sid­er­a­tion for op­er­a­tions but also for cap­i­tal im­prove­ments a.k.a. debt ser­vice.

The lim­i­ta­tion on the de­ductibil­ity may have an ef­fect on the out­come of bal­lots for school bonds in the fu­ture. It stands to rea­son that the in­crease in taxes nec­es­sary for the im­prove­ments be­ing con­tem­plated may not be as forth­com­ing in the fu­ture.

De­ductibil­ity for other state and lo­cal taxes, pri­mar­ily in­come taxes, would not be pre­served over the $400,000 limit. The bulk of the taxes that are col­lected are skewed to th­ese higher in­come lev­els. High wealth and in­come states would be par­tic­u­larly vul­ner­a­ble to this pro­vi­sion. Of course, there is also the weighty mat­ter of how the states that have in­come taxes would “har­mo­nize” with a vastly changed fed­eral sys­tem of tax­a­tion.

Cap­ping the mort­gage in­ter­est de­duc­tion at $500,000, down from $1,000,000, will also pose chal­lenges, although ex­ist­ing prop­erty hold­ings be­fore Nov. 2 are grand­fa­thered. The “move up” mar­ket will be greatly af­fected. As­sessed val­u­a­tion (AV) growth is linked to new growth and the ap­pre­ci­a­tion that has been ac­cu­mu­lated on ex­ist­ing prop­er­ties.

One has to come to the con­clu­sion that AV growth will prob­a­bly slow ap­pre­cia­bly. Once again, this ten­dency will serve to slow the growth in prop­erty tax rev­enues or the fun­da­men­tal rev­enue source for lo­cal gov­ern­ments.

One other pro­vi­sion that will serve to sup­press hous­ing turnover is the length­en­ing of the hold­ing pe­riod for the break from taxes on a hous­ing cap­i­tal gain to five years from two years. AV growth also climbs con­sid­er­ably at times based on hous­ing turnover ac­tiv­ity.

The four pro­posed tax brack­ets on the per­sonal side and the cor­po­rate tax bracket change to 20% will lead to greater sav­ings for tax­pay­ers of all kinds.

Ad­just­ing the thresh­old to $1 mil­lion for the 39.6% top bracket will serve to dis­suade some from in­vest­ing in mu­nic­i­pals. Mu­nic­i­pal is­suers will have to adapt sim­ply by of­fer­ing higher re­turns to in­vestors. At the same time, if PABs are no longer al­lowed, the mar­ket will be smaller by def­i­ni­tion.

How to adapt in the new en­vi­ron­ment? Con­sider buy­ing rev­enue bonds in “safe” sec­tors. Rev­enue bonds al­ready rep­re­sent ap­prox­i­mately 65% of is­suance. Gen­eral obli­ga­tion bonds will be more af­fected go­ing for­ward and it may take some time to de­ter­mine to what de­gree.


Also, tax­ing large en­dow­ments at col­leges and uni­ver­si­ties is a new one. I thought we cared about col­lege affordability! Many other pro­vi­sions will also af­fect higher ed­u­ca­tion if adopted.

We know that the fi­nal bill will in­evitably be trans­formed be­fore adop­tion. But many of the base case pro­vi­sions will be pre­served through the process. Some doubt whether there will be any bill, but the mo­men­tum is there along with the con­cern over the mid-term elec­tions. Mu­nic­i­pals are clearly be­ing asked to forgo a lot of con­sid­er­a­tion for the greater good.

Re­peal­ing AMT will be a boon to out­stand­ing hold­ers of AMT bonds and will be a pos­i­tive for many mid­dle class tax­pay­ers that have had to pay the AMT and who were not the orig­i­nal tar­gets for same.

The time to voice op­po­si­tion is now!

John Hal­lacy is a con­tribut­ing edi­tor at The Bond Buyer fol­low­ing a long ten­ure in the mu­nic­i­pal business, pre­dom­i­nantly as head of mu­nic­i­pal re­search for Bank of Amer­ica Mer­rill Lynch. John has also spent time as an an­a­lyst and man­ager at S&P Global, un­der­writer and mar­keter at four bond in­sur­ance com­pa­nies, and has served as the head of MAGNY and pres­i­dent of the So­ci­ety of Mu­nic­i­pal An­a­lysts.

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