MuniLand

MMA’s Posner: “It’s possible that the 28% #muniland tax cap could be brought up in the lame duck but not passed”#bbmash

— Cate Long (@cate_long) November 8, 2012

At the Bloomberg Link conference on Thursday, Matt Posner, of Municipal Market Advisors, said that discussion of the municipal bond tax exemption would likely be rolled over to the next session of congress, which begins January 3. Yes, the long awaited muniland battle is upon us. Strap on your armor.

Ever since President Obama created the National Commission on Fiscal Responsibility and Reform (Simpson Bowles) in 2010, the subject of reducing or eliminating the federal tax exemption for muni bonds has been kicked around. The administration proposed, in 2011, to “reduce the value of itemized deductions and other tax preferences to 28% for families with incomes over $250,000.” Muniland’s tax exemption has a big fat target on its back.

Many in Congress believe that the muni tax exemption benefits the wealthiest households in the U.S. In fact, IRS (2009) data shows that 151,098 households with annual incomes over $1 million get almost $16 billion of non-taxed interest from municipal bonds:

Another approach would be to make munis taxable and attract other classes of investors, especially 401(k) and IRA account holders, as I wrote in September of 2011:

The Joint Committee on Taxation is circulating an analysis of tax reform proposals, one of which includes removing the municipal bond tax exemption for all bonds issued after December 31, 2012. If the tax exemption is repealed or capped so that the federal government can collect more tax revenue, bond prices will fall. The higher yields would repay investors for their loss of tax exemption, nevertheless, groups are forming to oppose proposals to repeal the exemption.

Republican presidential candidate Mitt Romney has not indicated any specifics about how he would treat muniland in his tax reforms. President Obama has proposed changes. The Bond Buyer summed up the President’s position:

Some market participants contend that Obama’s plans to raise tax rates and permanently reinstate the Build America Bond program would help the muni market, despite his plan to cap the value of tax-exemption at 28% for higher income earners.

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 a series of decisions that may affect healthcare nationally, Illinois is tightening the noose on hospitals that claim tax-exempt, non-profit status. What began as the denial of a property tax exemption by the Champaign County Board of Review for one hospital system in 2002 has become a state-wide analysis of how much actual “charity care” hospitals are providing.

The immediate implication is that hospitals’ property tax exemptions could be revoked and vital revenues could be collected. However, this raises a broader structural question around the use of tax-exempt municipal bonds for entities that may be passive vehicles for for-profit activity.

Becker’s Hospital Review has the specifics:

[T]he Illinois Department of Revenue’s crackdown on Illinois non-profit hospital tax-exempt statuses came on the heels of an Illinois Supreme Court ruling from last year. In 2010, the Illinois Supreme Court ruled that Provena Covenant Medical Center in Urbana, Ill., could not qualify for property tax-exempt status because it did not provide enough charity care to its community, although Provena argued that it provided millions of dollars in other free care and community benefits.

There is a very blurry line in muniland between truly public activities and private activities that allegedly have some public good, and into this ill-defined space, for-profit and non-profit organizations have found ways to issue tax-exempt municipal bonds. This gray area should be a prime target for Congress to examine when it goes looking for ways to raise more tax revenue from muniland.

It’s easy to find these quasi-public projects. A quick look at the listing of today’s new bond offerings on EMMA immediately produces this $29 million bond offering at the private Rollins College in Florida to fund the renovation of its science center, campus center and one of its residence halls. There is an additional $15 million bond offering at the college to refund bonds previously issued at a higher interest rate. These bonds are being issued through Florida’s Higher Education Facilities Financing Authority, which is acting as public conduit for the private school. Rollins, an exclusive southern college, charges $50,400 per year for tuition, room and board. At these tuition levels it’s hard to see how much good the general population receives.

A more egregious example in today’s muniland bond offerings is the remarketing agreement for $14 million in bonds issued for Koch Industries subsidiary Georgia-Pacific to acquire and construct solid waste disposal facilities in the Parish of East Baton Rouge, Louisiana. In the case of the Koch bonds, the conduit authority is the Industrial Development Board of the parish. Koch Industries is not some small fish — just last year Forbes listed it as the second-largest privately held company in the country with estimated annual revenues of $100 billion.

Bloomberg had a great piece that rounds up the factors that made municipal bonds the best performing financial asset of the past year. The story is framed as a knock on Meredith Whitney for her scare call a year ago:

This was supposed to be the year the $3.7 trillion state and local debt market would be rocked by an exploding pension time bomb and “hundreds of billions of dollars” of defaults, according to analyst Meredith Whitney.

Whitney’s Armageddon never came. Instead, munis became the star performers of 2011.

The weakest states are stronger than US banks

I noticed something very interesting in some research that Markit, a data provider that tracks the credit-default swap market, released yesterday: the worst U.S. municipal credits (California, Illinois and New Jersey) are considered much stronger than all the major U.S. banks save JP Morgan. New York state is considered stronger than Mr. Dimon’s bank!

Why this is especially important in muniland is that these U.S. banks write a lot of credit-default swaps insuring the debt of these large states, which seems upside-down given that credit markets view the banks as weaker than the states they insure. This raises questions about the validity of the whole muni CDS market. I’ll dig around on this issue a little more.

Heavy political support for ending municipal-bond tax exemption

Bloomberg writes about several strong political forces in favor of ending the tax exclusion from municipal bond interest payments. I still haven’t seen a definitive cost analysis of the change though. Maybe the President’s proposal to reduce the tax exclusion on muni bonds for those earning over $200,000 is a signal to Republicans that the administration is willing to negotiate the issue. From Bloomberg:

We are making some headway on unemployment although some states still have substantial problems. For the larger, original version from Calculated Risk Blog click here.

Muni tax exemption “on the table”

Bond Buyer reports:

Two weeks ago, about a dozen issuer advocates met with staff members for Democrats and Republicans on the Senate Finance Committee to emphasize the important role tax-exempt bonds play in infrastructure development.

The issuer groups were told by staffers that the tax exemption of muni bonds was on the table as part of discussions on spending cuts, and that the committee may soon schedule hearings on this subject, sources involved with the meeting said.