Bond dealers and local government officials are on high alert after
Mitt Romney’s team suggested the GOP nominee could target the
tax-exempt treatment of municipal bonds in a reform effort.

With both parties interested in pushing for a tax overhaul, backers of the bond break say they are more worried than they’ve been in years about protecting it.

{mosads}The incentive took less of a hit than other preferences in the last round of tax reform in 1986, but only after a fierce struggle.

Supporters are ramping up efforts to educate lawmakers about the importance of tax-free bonds by stressing the positive impact that they have on towns and cities nationwide.

“If we do our part to really educate Congress about the importance of municipal bonds, we think they’ll look elsewhere,” said Susan Collet, senior vice president of government relations for the Bond Dealers of America. “We have to explain how these tax savings for investors in fact makes it cheaper for cities and other governments to build infrastructure.”

Many on Capitol Hill expect the debate over revamping the tax code to heat up next year no matter who controls the White House, and champions of the municipal bond preference aren’t the only ones looking over their shoulder. But there also may be good reasons for bond supporters to be on the defensive.

The municipal bond lobby’s efforts come amid increased debate over Romney’s tax reform plan, which calls for slashing individual rates across the board without adding to the deficit, or the tax burden of the middle or lower class.

Romney has declined to pinpoint which tax breaks he would seek to limit in an overhaul, and skeptics like the nonpartisan Tax Policy Center said it would be impossible for Romney to check off all his goals without shifting some of the tax burden away from the rich.

But conservative allies like The Wall Street Journal editorial page and the American Enterprise Institute pointed out that the tax center had assumed Romney would not touch the incentives for municipal bonds or interest on life insurance savings — tax breaks that not only cost billions of dollars, but whose benefits mostly flow to the wealthy.

“Those are the largest and most easily accessible of the tax expenditures that they assumed were off the table,” AEI’s Matt Jensen, who penned a response to the Tax Policy Center analysis, told The Hill.

State and local governments sell municipal bonds to investors as a way to finance a range of public projects, from roads to schools to hospitals. Investors — in exchange for essentially lending money to the governments — get interest payments in return.

Howard Gleckman of the Tax Policy Center said that, while exact data was hard to come by, it was probably safe to assume that those making $200,000 or more per year get roughly 80 percent to 85 percent of the tax benefits from exempt municipal bonds.

That’s largely because, Gleckman said, those taxpayers often have more money to invest and get a more generous tax benefit because of their higher rate.
Local government officials have termed tax-exempt bonds a winner for both the taxpayer and local governments, which save an average of 2 percentage points on borrowing costs. Some $287 billion in municipal bonds were issued in 2011, according to data from Thomson Reuters, a sharp decline from previous years.
Tim Firestine, the chief administrative officer of Montgomery County, Md., said that while the municipal bond tax break might benefit the wealthy, taking it away would likely raise the tax bills on families with more moderate incomes.

“If we have to pay that larger cost to borrow money, we’d have to look at areas like increased property taxes, which really hit the middle-income taxpayers,” Firestine said. “If we have to build a school, we’re still going to build that school.”

Supporters of the municipal bond break also argue that taxpayers across the wealth spectrum benefit from the infrastructure improvements funded by bonds, and that municipal bonds are a well-known investment that provides stability to the market.

Collet, from the Bond Dealers of America, said that backers would be up and running with education efforts in 2013 no matter who is in the Oval Office. A task force consisting of both the government officials that issue municipal bonds and bond dealers would likely be formally launched this fall, Collet added.

But the Journal editorial page, among others, isn’t convinced that the municipal bond break is a winner, declaring that it merely promotes increased borrowing and spending by state and local governments.

With that in mind, the editorial board also pushed back on the Tax Policy Center for assuming that Romney would not carve up the municipal bond break because it was linked to savings and investment, something Romney has said he wants the tax code to encourage.

“Whether that’s the best way to subsidize local activity is a complicated question, as is how much local activity should be subsidized,” said Jensen.

Even if policymakers did take a look at the municipal bond break, they would face serious questions about how to limit it. There is also some doubt about how much revenue could be had from curtailing the preference.

Officials, for instance, would have to decide whether to only limit the tax break for new municipal bond purchases, given that investors have currently purchased the bonds with the tax incentive in place.

Jensen of AEI has estimated that rolling back the municipal bond and life insurance incentives could net as much as $90 billion in revenue per year.

But the Tax Policy Center put that figure at more like no more than $49 billion, noting that, by lowering tax rates by 20 percent, Romney would be able to squeeze less revenue out of specific tax breaks.

“That’s the paradox,” the Tax Policy Center’s Gleckman said. “When you reduce rates, you get less revenue from eliminating the tax preference. It’s very difficult math to get around.”