2017 in Finance – What Lies Ahead?
2017 promises, and threatens, to be a potentially momentous one for public finance in the United States. The Trump Administration and the 115th Congress may put in place tax reforms and infrastructure programs that will have transformative consequences for the financing of public projects in all sectors and at all levels. These are only a few of the issues that state and local officials and public finance professionals will be following closely in the coming year:
Will income tax rates be reduced and, if so, will lower rates reduce the relative attractiveness of tax-exempt municipal bonds?
Will new restrictions be placed on the purposes for which tax-exempt bonds may be issued or on the manner in which they may be sold, or how their proceeds may be invested?
Will the new Administration pursue the trillion-dollar, ten-year infrastructure program that President Trump proposed during the campaign? Will Congress approve it? If so, which categories of infrastructure improvements will be given priority?
How will any major infrastructure program be paid for? As a candidate, President Trump indicated that he would propose new tax credits as a funding method. If enacted, would those tax credits enhance or undermine traditional municipal bond financing?
Will the Alternative Minimum Tax be eliminated and, if so, will that increase the relative attractiveness of “AMT Bonds” (e.g., exempt facility bonds) commonly issued to finance certain types of large infrastructure projects?
With that introduction, please find below our latest report, discussing the latest policy developments surrounding Congressional tax reform efforts, followed by a discussion of where key policymakers stand with regard to the tax exemption for interest on municipal bonds.
With the 115th Congress officially under way, policymakers are beginning to move forward with a number of policy priorities – including, at the top of the list, tax reform. Thus far, much attention has been given to the Ways and Means Committee’s efforts on its tax reform “Blueprint,” which “represents a dramatic reform of the current income tax system” (Lawmakers target the tax-exemption for municipal bonds……..again). Specifically, the proposal addresses various issues, including: (1) individual taxation; (2) corporate taxation; (3) international taxation; and (4) the need to reform the Internal Revenue Service (IRS). Importantly, the Blueprint would eliminate “special-interest deductions and credits in favor of providing lower tax rates for all businesses and eliminating taxes on business investment.” This presents opportunities and risks for a wide-array of taxpayers and stakeholders – including those who benefit from the tax exemption for municipal bonds, which includes both the holders of the bonds and the state and local government issuers of municipal bonds and their conduit borrowers, who benefit from the lower interest costs that municipal bonds typically provide.
We have learned that legislative text to implement the Blueprint is already being drafted, though there are several holes and significant details that still need to be filled in. To begin to fill out these missing pieces, Republican Ways and Means members have begun to organize into working groups, holding member-to-member meetings to discuss their preferred approach and work through any issues. While the exact timing of the release of any legislation is uncertain, tax reform is a priority that we expect will begin to be addressed in a substantive way during the first 100 days of the Trump Presidency – thus, we are likely to see legislative text released by April.
With regard to the Senate’s tax reform efforts, it appears that all 13 GOP members of the Senate Finance Committee are working in lockstep and are seeking to understand the real-world implications of the Blueprint. That said, it does not seem that Finance Committee members are wedded to the Blueprint, but instead are proceeding as if the Committee may need to do its own bill. At a minimum, we expect the Committee will take up and amend the Blueprint. As such, the Senate Finance Committee is in “watch and listen mode,” so any Finance Committee draft legislation or recommendations are unlikely to be released in the next few months. Regardless of the approach, bipartisanship will be difficult; as such, because Republicans do not want to miss the opportunity to lower rates, tax reform through budget reconciliation is a real possibility, something Majority Leader Mitch McConnell (R-KY) confirmed last month.
As for the Finance Committee Democrats, Minority Staff has emphasized that the Blueprint is “inherently partisan” and should not be done under reconciliation. From our perspective, this serves as their opening shot to work with GOP staff on a compromise position. Though reconciliation remains an option, achieving it may require (pursuant to the Byrd Rule) the entire tax reform package to sunset in 2028 – something both parties want to avoid. As such, we continue to believe that Senate Democrats will wield significant influence over the process and should not be discounted.
With regard to substance and what provisions are likely to be eliminated to help pay for lower rates, there is still uncertainty as to exactly which provisions are on the chopping block, including the tax exemption for interest on municipal bonds. Although the Blueprint does not reference municipal bonds specifically, it does mention repealing unnamed “special-interest” provisions, which could very well extend to the tax-free treatment that municipal bond interest receives. This is particularly important in light of the position that certain incoming Trump Administration officials have taken with regard to municipal bonds. In particular, Wilbur Ross, President Trump’s Commerce Secretary nominee, and Peter Navarro, President Trump’s pick to lead the National Trade Council, have argued that municipal bonds are not an efficient way to pay for public projects. The two authored a paper this Election cycle explaining certain problems with tax-exempt bonds and outlining alternative methods that could be used to help finance infrastructure products. Specifically, the paper notes that private investment and federal tax credits could serve as a “critical” supplement to existing financial programs (such as the tax exemption on municipal bond interest) and public-private partnerships.
In sum, tax-writers and their staff are presently drafting legislative language that could shape reforms to the Tax Code that will last for a generation. As such, because the current approach targeting lower tax rates requires the elimination of many provisions upon which taxpayers rely in their tax planning, stakeholders should be prepared to share data and arguments as to why particular provisions should remain in the Tax Code. This holds true in particular for those taxpayers and stakeholders who benefit from tax-exempt municipal bonds, as that exemption could very well be caught up in the overall tax reform process.