Bond dealers see ‘here and now threat’ to century-old tax break

Backers of the tax exemption for municipal bonds remain on high alert after escaping the “fiscal cliff’ unscathed.

Players in the $3.7 trillion municipal bond market argue the tax preference on interest helps fund a range of initiatives and sectors across the country, from infrastructure projects to student loan providers.

But with more deficit negotiations on the horizon, both Democrats and Republicans have made a case for at least limiting the exemption.

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That has left supporters worried that a tax incentive that has been on the books for a century could be sacrificed in negotiations over looming sequester cuts, the debt ceiling or a measure to fund the government.

“It’s a real here and now threat,” Mike Nicholas, the chief executive of the Bond Dealers of America, told The Hill. “Pretty much every meeting on the Hill we have, people are saying, ‘Yes, you should be concerned,’ and ‘Yes, this is being considered as a revenue raiser.’”

Under the current set-up, state and local governments sell municipal bonds to help pay for projects such as schools, roads and hospitals.

In exchange, investors who are basically lending money to the public sector get interest payments. Investors also are generally willing to exchange a lower interest return for the tax break.

Supporters say the popularity of municipal bonds and the sheer size of the market — there are roughly 46,000 bond issuers, according to some estimates — will give them an advantage as they lobby Washington.

“One of the goals here is to educate on just what munis are, and just how munis impact virtually every aspect of your life,” Nicholas said.

Mayors from across the country who were in Washington this week for a conference warned that rolling back the tax exemption could make it harder for cities to borrow money and make key investments.

If the tax exemption were rolled back, state and local governments would likely be forced to offer bonds at higher interest rates to investors.

But with policymakers staring at trillions of dollars in debt, bond issuers and government officials acknowledge that they have a challenge in convincing officials that the policies the municipal bond exemption support are well worth the billions of dollars in lost revenue to the Treasury.

“This is like water coming in through a leaky roof,” said John Godfrey of the American Public Power Association (APPA), which represents public utilities that use tax-exempt bonds. “You plug one hole, and it finds another.”

Top Democrats have said they want to target tax preferences used by the top earners after securing a fiscal cliff deal that raised some $600 billion in taxes while extending all but the highest Bush-era rates.

On that front, President Obama has previously called for capping tax deductions at 28 percent, a plan that would effectively force those paying a higher rate to pay taxes on their municipal bond interest.

Republicans, meanwhile, have said the revenues raised in the fiscal cliff deal are more than sufficient.

But at the same time, key conservatives raised questions about the municipal bond break during the 2012 campaign, saying it facilitated increased borrowing and spending from local governments.

Supporters of the exemption, including the Bond Dealers of America, formed Municipal Bonds for America to lobby for the exemption. The coalition includes local groups.

Nicholas, from the Bond Dealers of America, said the group has held hold dozens of meetings with lawmakers and staffers from both parties.

Godfrey, of APPA, said his group was calling on hundreds of its member utilities to contact their state and federal lawmakers.

Supporters like Vince Sampson of the Education Finance Council are pushing for the exemption and its benefits to be considered in the broader discussion over tax reform and the future of the tax code, and not just as a deficit-reduction tool.

“This needs to be a tax policy conversation, not just a budget conversation,” said Sampson, whose group represents nonprofit student lenders. “We need to explain what you get for these revenues, to focus on the benefits of the exemption.”

“This is a very robust debate that needs to happen outside this fiscal crunch,” he added.

Godfrey also said that, until recently, supporters might have underestimated the challenge in preserving the exemption, which was codified in 1913 and kept mostly intact during the last broad overhaul of the tax code in 1986.

“In part because it was there for so long, not enough people knew why the exemption existed,” Godfrey said.

Now, supporters are brandishing reports, like a new analysis from Citigroup, that say the case for rolling back the exemption are thin.

Backers also say they will push hard to keep the entire exemption intact, and won’t support proposals like limiting the exemption for just newly issued bonds.

“It ain’t broke, and doesn’t need fixing by full measures or half measures,” Sampson said.