A smarter way for Congress to talk about muni tax code

April 27, 2012

Chris Mauro, head of U.S. municipal strategy at RBC Capital Markets, sent around a comment note suggesting that the media coverage of the Senate Finance Committee hearing Wednesday that included discussion of possible changes to the taxation of municipal bonds was overheated:

Yesterday, the Senate Finance Committee held a hearing entitled “Tax Reform: What It Means for State and Local Tax and Fiscal Policy”. A simple reading of the media accounts of this hearing would lead one to believe that the entire event was dedicated to a detailed discussion of the future of the tax-exempt status of municipal bond interest. So we decided to review the tape of the hearing in order to see what in fact was discussed. In reality, the vast majority of the hearing was focused on two issues – the deductibility of state and local taxes by federal taxpayers and the ability of state and local governments to collect sales taxes on internet and catalog purchases.

Both Committee Chairman Max Baucus and Ranking Member Orrin Hatch made some passing comments about tax-exempt bonds and the federally subsidized taxable Build America Bond (BABs) program, with Baucus making generally positive statements about BABs and Hatch making generally negative ones. Senator Maria Cantwell of Washington State expressed some concern about the importance of tax-exempt bond financing to public power utilities in the northwest, but beyond that, there wasn’t a whole lot of discussion about the muni tax exemption.

In our view, the biggest take-away from the hearing was just how far away we seem to be from a comprehensive tax reform package actually becoming reality. We found it informative that at several points during the hearing, Senator Baucus discussed the difficulty Congress has in identifying which tax expenditure items need to be cut in order to lower overall tax rates, asking the witnesses during one exchange to contribute some creative ideas in that regard. This confirms something that the market already knows but needs to be continually reminded of – real comprehensive tax reform is extremely difficult to pull off and will take a considerable amount of time to accomplish.

I didn’t watch the hearing but it sounds as if RBC’s Mauro read the tea leaves pretty well. I’m sure that Congress is having difficulty identifying where to amend the tax code to make it fairer and raise additional revenue or have revenues remain neutral. The deliberative congressional process gives all the issue’s players a chance to be heard, and tax matters are often the most fiercely fought. But the other thing I noticed in Mauro’s note was that Congress is looking for new ideas to address this complex issue.

One idea that I’m interested in is having Congress more narrowly define what constitutes a “municipal bond” issued for the public good. In muniland there are a lot of private activity bonds that do not provide infrastructure or services for the general public but rather for a select audience that must pay substantial amounts to gain access. The tax-exempt bonds of “non-profit” hospitals offer the most obvious example, as I wrote several weeks ago:

As the legislative and executive branches thrash out the exact standard for how much charity care a hospital must provide, the deeper issue of for-profit entities using most of the physical space in a tax-exempt, non-profit building needs more attention. The original county review that sparked Illinois to look more closely at non-profit hospitals, that of the Provena Covenant Medical Center, detailed the extent of for-profit activity in the system:

“Provena Covenant Medical Center allows outside, for-profit entities to use the facilities to generate personal and/or corporate profit. There are multiple outside physicians’ groups and service providers who use the hospital to serve patients. These physicians’ groups are for-profit entities that practice in the hospital and then bill patients for work done in what is claimed as a tax-exempt property…”

I’ve also written about Exxon Mobil and Koch Industries, which have tax-exempt bonds for refinery facilities and waste treatment plants, respectively, in Louisiana. As Congress thinks about creating greater fairness in the tax code, the tax exemption for private activity bonds is one place to look, and I’m sure there are other areas where changes could be made.

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