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Hill Dems pick apart Obama jobs plan

Posted by on Sep. 14, 2011 at 2:36 PM
  • 4 Replies

President Barack Obama’s new jobs plan is hitting some unexpected turbulence in the halls of Congress: lawmakers from his own party.

As he demands Congress quickly approve his ambitious proposal aimed at reviving the sagging economy, many Democrats on Capitol Hill appear far from sold that the president has the right antidote to spur major job growth and turn around their party’s political fortunes.

“Terrible,” Sen. Jim Webb (D-Va.) told POLITICO when asked about the president’s ideas for how to pay for the $450 billion price tag. “We shouldn’t increase taxes on ordinary income. … There are other ways to get there.”

“That offset is not going to fly, and he should know that,” said Democratic Sen. Mary Landrieu from the energy-producing Louisiana, referring to Obama’s elimination of oil and gas subsidies. “Maybe it’s just for his election, which I hope isn’t the case.”

“I think the best jobs bill that can be passed is a comprehensive long-term deficit-reduction plan,” said Sen. Tom Carper (D-Del.), discussing proposals to slash the debt by $4 trillion by overhauling entitlement programs and raising revenue through tax reforms. “That’s better than everything else the president is talking about — combined.”

And those are just the moderates in the party. Some liberals also have concerns.

“There is serious discomfort with potentially setting up Social Security as a fall guy because you’re taking this contribution out,” said Rep. Raul Grijalva of Arizona, referring to Obama’s proposal to further slash payroll taxes.

Democrats in large numbers will still back the president’s overall jobs package, and when the plan heads for House and Senate consideration, some of these same skeptics will very likely vote to advance the measure. But as details of the plan began to be vetted on Capitol Hill on Tuesday, it was clear that the White House needed to redouble its sales job — or tweak its plan — to force Democrats to fall in line at a pivotal point in Obama’s presidency.

White House officials aren’t ruling out making changes to the bill or compromising with Republicans on pieces of the agenda, and they plan to brief Senate Democrats on Thursday. But following his joint address to Congress last week, Obama, in a feisty speech Tuesday in Columbus, Ohio, again ratcheted up pressure to “pass this bill.”

“Tell them that if you want to create jobs right now — pass this bill,” Obama said. “If you want construction workers renovating schools like this one — pass this bill. If you want to put teachers back in the classroom — pass this bill. If you want tax cuts for middle-class families and small-business owners, then what do you do? Pass this bill.”

The audience shouted back, “Pass this bill!”

But in the halls of Congress, “this bill” was already expected to be modified, pared back significantly or overtaken by the powerful new deficit-slashing supercommittee.

“It’s hard to have an opinion on something you don’t think is going to be the final product,” said Nebraska Sen. Ben Nelson, a conservative Democrat who faces a tough reelection next year. “I’ve made it clear I’m looking for [tax] cuts, so I’m very hopeful there will be cuts.”

The wide-ranging reaction from Democrats speaks to the dilemma facing Obama as he heads into a tough reelection with the threat of economic recession looming: He needs to show the public that he’s pushing forward a bold and detailed plan to reverse the 9.1 percent unemployment rate, but his low approval ratings have made it harder to push a bill through a deeply divided Congress.

The push to inject cash into the economy has left Democrats stuck between pushing a jobs bill while trying not to add to the deficit.

“Every dollar that is spent on the jobs bill … is not going to be available to Congress to deal with the debt,” said Sen. Joe Lieberman of Connecticut, an independent who caucuses with Democrats. “And to me, the top priority of ours should be long-term major debt reduction.”

Lieberman insisted he was still open to backing the Obama plan, but he said the revenue raisers laid out in the plan raise “questions about whether it will be paid for over the long term.”

The new congressional supercommittee, created by last month’s law to raise the debt ceiling, could very well play a large role for the Obama jobs plan, which calls on the panel to find additional cost savings to help pay for it. In an effort to push the committee to find additional cuts in the range of $4 trillion over the next decade, a bipartisan group of senators met Tuesday morning in an effort to push the panel in that direction.

And next week, the White House plans to unveil what Obama says is a long-term deficit-reduction plan — on top of the measures that administration officials say will fully offset the costs of the new jobs proposal over 10 years.

In the jobs plan, Obama proposes to expand payroll tax cuts so employees’ rates would be reduced to 3.1 percent in 2012, down from the original rate of 6.2 percent that helps fund Social Security. A number of tax credits would be extended to businesses that hire workers and purchase new equipment. Billions would be spent on school construction, the hiring of teachers, the enlistment of more first responders, the rebuilding of infrastructure and for construction companies renovating old homes. Unemployment benefits would be extended through 2013.

To pay for nearly $400 billion, the White House would limit to 28 percent itemized deductions for families earning more than $250,000. Some $18 billion would be raised by increasing taxes on income earned by investment funds, another $40 billion would be raised by repealing certain subsidies for oil and gas drilling, and $3 billion would be raised by overhauling how taxes are treated for corporate jets.

Limiting deductions to upper-income families was opposed by all but three senators in the Democratic-controlled Senate in 2009. But some of those who voted against the idea in 2009 say they’d be open to backing it as part of a comprehensive package.

“The president has laid out a package, laid out a way of paying for it, I have no trouble supporting it,” said Democratic Sen. Kent Conrad of North Dakota.

Similarly, while some Democrats worried about the impact further cuts to the payroll tax would have on the Social Security program, and whether it would spur job growth, some like Sen. Ben Cardin (D-Md.) said they could swallow it as part of a more sweeping proposal.

But the tax increases clearly have generated concern among a number of Democrats who are calling for broader changes rather than tax hikes on specific industries.

“If we’re going to change something, we got to be sure that we do it in the total [tax reform] package, that they know what the rules of the road are,” said Sen. Kay Hagan (D-N.C.).

Democratic Sen. Mark Begich, from the oil-rich state of Alaska, said it was “frustrating” to see the president single out the oil industry after calling on the congressional supercommittee in last week’s address to Congress to find savings.

“When you start singling out certain industries, there’s an unfairness to it,” he said in an interview. “On the pay-fors, I have a problem.”

http://dyn.politico.com/printstory.cfm?uuid=DEF91CE7-00CC-4D50-8666-DA41AEF46CB6

by on Sep. 14, 2011 at 2:36 PM
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Replies (1-4):
candlegal
by Judy on Sep. 14, 2011 at 2:51 PM

they want to get re-elected and they know supporting another stimulus bill will not make that happen.

2hotTaco
by on Sep. 14, 2011 at 2:52 PM

Nor will agreeing with republicans.

Peanutx3
by Ruby Member on Sep. 14, 2011 at 2:59 PM

There are some interesting side effects of this job bill.  I got the following article from CitiGroup.


Why Is The Tax-Exempt Status Of Municipals Under Assault?

·         The Administration's new Jobs Bill includes an unpleasant surprise for state and local governments

·         Specifically, the bill would cap the value of the tax exemption for high-income investors at 28%. This change would, in our view, increase state and local borrowing costs significantly, and for the first time, create a retroactive change to tax exemption.

·         While this provision is unlikely to be enacted in its current form, it cannot be ignored, because it could come back again as deficit reduction and/or tax reform moves forward.

·         Ironically, one of the purported reasons for this change is to pay for an Infrastructure Bank, a less effective way to support state and local financing than the muni market itself.

·         A key problem for supporters of tax-exempt financing is that the cost of such financing to the Treasury is consistently overstated. A recent study in the National Tax Journal explains why.

Why Is The Tax-Exempt Status Of Municipals Under Assault? 

Summary and Conclusion

On Monday, September 12, the Obama Administration unveiled its new jobs legislation, including for the first time the details of how it would pay for the new costs associated with the program. This section included a potential shock for municipal investors and issuers: for existing and new bonds, the bill would cap the benefit of the tax exemption at 28% for individuals with an adjusted gross income of $200,000 or more and for families with an adjusted gross income of $250,000 or more. For investors in those categories, any tax benefit in excess of 28% would have to be conveyed to the Federal government in the form of a tax. In other words, for an investor in the 35% Federal tax bracket, tax exempt income would now be taxed at 7%.

In our view, this proposal is a serious departure from historical tax policy regarding municipal bonds in that it would be applied retroactively as well as on new bonds. In our view the combination of the new tax and the breach of faith inherent in retroactive taxation would cause borrowing costs for state and local issuers to rise dramatically. We view this primarily as a tax on state and local issuers, NOT on investors, who would simply require a higher borrowing cost on new bonds they purchase, to make up for the tax AND for this new, higher tax risk.

A Shock to State and Local Governments in the President's Jobs Bill.

On Monday, September 12, the Obama Administration unveiled its new jobs proposal, "The American Jobs Act of 2011." The proposal includes a grab-bag of ideas, designed to stimulate job growth, which are likely to create widespread disagreement among economists and members of Congress as to their effectiveness and cost vs. benefit. The bill would provide proceeds for highway repair and construction and other transportation facilities. It would create a new "American Infrastructure Financing Authority"--An Infrastructure Bank-- with the capacity to provide direct loans and loan guarantees to facilitate investment in economically viable infrastructure facilities of regional or national significance.

One new provision, however, was a genuine shock to both investors and issuers in the municipal bond market: As part of the way to pay for all of this, the bill contains a provision which would be likely to severely impair the functioning of the tax exempt market, if enacted. Namely, the bill caps the benefit from receiving tax exempt income and other deductions (including mortgage interest) at the 28% rate. The cap applies to individuals with adjusted gross income of $200,000 of greater and married couples earning $250,000 or more. As we discuss below, we believe that this provision, if enacted would dramatically increase borrowing costs for state and local governments, while in many cases substituting the judgment of a Federal Bureaucracy for the "sort and selection" mechanism provided by the capital markets, both for tax exempts and for Build America Bonds. The following is a relatively brief summary of our initial thoughts on what we believe to be a very poorly designed component of the legislation, which could actually SLOW spending on state and local projects such as infrastructure, rather than accelerating it.

How Would The New Tax Provision Affect The Muni Market?

In our view, there are a number of concerns generated by this provision:

1. The Household Sector is a very large component of the demand for municipal bonds, especially for long-term bonds that are specifically used for infrastructure projects. Working with IRS data for 2009, we find that roughly 45% of muni interest is in the hands of individuals with an adjusted gross income of $250,000 or more and 49% is in the hands of individuals exceeding the $200,000 threshold. This provision would thus, for the first time place a tax on otherwise tax exempt income for a very large number of investors in munis.

2. The size of that tax would be 7% of muni interest for investors in the 35% tax bracket. So, the yield on a bond that had earned 4% tax-free would be reduced by 28 basis points for high-bracket investors, to 3.72%.

3. If the Bush tax cuts were to expire or the maximum income tax rate were otherwise increased, the tax on muni interest would go up, always set at the investor's maximum tax rate minus 28%. In the 39.6% tax bracket, for example, the tax rate on muni interest would be 11.6%, pushing the after-tax yield on the 4% bond in our example to 3.536%. There is another way to view this in terms of comparisons with the taxable bond market: taxable equivalent yield. To use the 4% bond example, the taxable equivalent rate in the 35% tax bracket would be 6.15%. At the 28% rate, it would fall to 5.55%. So you're chopping 60 basis points off the taxable-equivalent yield. To get back to the original 6.15% taxable-equivalent yield under this new regime, the tax-exempt muni yield would have to rise from 4.00% to 4.43%. That's a 43 basis point penalty for issuers on the long-end, even before you add a tax-policy risk premium, and the potential impact of the Bush Tax Cut expiration. When we get back to 39.6% regime, the muni yield would have to rise from 4.00% to 4.77% to make that top-bracket investor indifferent.

4. Clearly, high-income muni investors would require a higher yield on municipal bonds to make up for the new tax, pushing state and local borrowing costs significantly higher, based upon simple arithmetic.

5. However, in our view, the implications of this provision, if enacted, would be far greater than the arithmetic suggests, for several reasons. For one thing, this is the first case that we are aware of where the tax benefit derive from owning municipals is being cut retroactively. There was a strong recognition, throughout Congress, that investors had accepted a lower yield based upon the belief that their muni interest would not be taxed. Therefore, based upon ongoing discussions with Congress, we have always believed that no change in the tax treatment of municipals would be applied to existing holdings. Based upon this new provision-even if never enacted into law-that belief is no longer valid. The Administration has clearly announced a willingness to change the tax status of bonds already issued and owned, something that has NEVER before been considered seriously, that we are aware of. Going forward, the muni market is likely to exact at least a modest tax risk penalty to account for the risk of retroactive taxation, thus pushing state and local government borrowing costs higher to an extent that the math simply does not capture.

6. Finally, it is important to stress that the main cost of this would not fall on muni investors, but on state and local governments. Investors would be made whole by demanding a higher yield on new bonds purchased. Devaluing the muni tax-exemption will simply drive up tax-exempt interest rates. Devaluation of the exemption is a tax on state and local governments, plain a simple. This is not to say that there isn't a cost for investors, but probably not in the way intended:

this provision, if enacted, would drive down the value of bonds already owned by investors. In our view, however, this market effect has no corresponding benefit for the Federal Government.

The Tax-Exempt Municipal Bond Market Is Far Superior To an Infrastructure Bank

In our view, the tax-exempt municipal bond market is far superior to an Infrastructure Bank as a way to provide low-cost funds for state and local projects. The United States has a long history of providing financial support for state and local projects through a Federal Bureaucracy-through the Bureau of Reclamation and the Army Corps of Engineers, through the Federal Highway Administration, and though provisions of ARRA, the 2009 stimulus bill. In virtually all of those cases, a Federal Bureaucracy working independently of the capital markets was a poor substitute for state and local financing. Approval of projects tended to be extremely slow, poorly targeted, and highly subject to political pressures. By contrast, the capital markets-either through tax-exempts or BABs, had extremely important advantages as providers of timely low-cost capital:

·         Projects were selected based upon the willingness of the issuer to undertake the project and make repayment on the debt issued for the project;

·         Issuers had a strong incentive to use proceeds efficiently in order to minimize annual debt service and maintain credit ratings;

·         There was never any incentive to accept a direct federal subsidy for a project simply because the money was there.

·         Projects could be funded and started based specifically upon the project administrator's time schedule simply by going into the capital market to borrow. This is not to say that direct Federal monies provided as grants could not provide an important adjunct to the capital markets. It simply suggests that Federal programs tend to work best when a state or local issuer, not a Federal Bureaucracy, is driving the process, and federal monies are combined with state or local borrowing in order to increase the combined capacity to provided funding for needed projects. The rapid turnaround and better targeting available through such an approach enhances its value as a support for new projects AND for putting project builders back to work. And of course, it avoids the PERMANENT stigma and tax risk premium that would be attached to any provision which goes in and taxes municipal bonds retroactively.

Conclusion: What now?

We believe strongly that the risks of this provision actually being enacted are quite low, IF, and ONLY IF, state and local interest groups remain in contact with their elected representatives in Congress to explain the severe disadvantages of an approach that beggars existing capital market mechanisms in order to provide substitutes to the capital markets. There are other provisions in the Bill that are likely to raise red flags to many lawmakers, such as the cap on the mortgage interest deduction. So, there is likely to be room to work with Congress to eliminate this unappealing change in the market for tax-exempt bonds. Subsidies provided through the capital markets, either through tax-exempts or in combination with BABS with an appropriately targeted subsidy rate, remain the most effective and efficient way, in our view, for the Federal Government to support state and local projects, even if combined with grant money provided at the Federal level.

One Final Note: The Cost of Tax Exemption To The Federal Government

In a sense, supporters of the tax exempt market have always been at a disadvantage because of the high estimates of the cost of tax-exempt financing to the Federal Government. Analysis by the Congressional Budget Office and the Congressional Joint Committee on Taxation has always assumed that if tax-exempt bonds are eliminated, investors would buy taxable bonds taxed at a high marginal rate. A recent study in the June 2011 National Tax Journal takes issue with that assumption1. In the article, the Authors conclude that: "Estimates of the revenue gain from eliminating the income tax exemption for interest paid by state and local governments are sensitive to assumptions about how taxable investors would adjust their portfolios in response to this change. If high-tax-bracket individual taxpayers shun bonds issued by state and local governments when the interest on those bonds is taxable, and if they invest instead in lightly-taxed assets such as low-yield corporate equities, the revenue gain from curtailing the exemption is likely to be substantially smaller than if these investors continue to hold state and local government bonds even after the interest becomes taxable. The extent of household portfolio adjustment depends on the degree to which households pursue tax-efficient investment strategies and on their desire to preserve the diversification that they currently receive from investing in state and local government debt. Shifting from such debt to lightly-taxed equity, one of the portfolio strategies we consider, would add volatility to the returns on household portfolios, since equities have historically displayed more variable returns than tax-exempt bonds. Changes in the mix of assets in household portfolios, offset in our analysis by shifts in the portfolios of non-taxable investors such as pension funds or investors from other nations, would affect the risk properties of the federal government's income tax revenue stream."

In our experience, this type of tax-efficient portfolio substitution is the norm, not the exception, meaning that Federal estimates of the cost of tax exempt financing tend to be overstated by a wide amount.


candlegal
by Judy on Sep. 14, 2011 at 3:13 PM

I am sure there are as once again he is trying to get them to pass it without reading it.  Thanks for posting.

Quoting Peanutx3:

There are some interesting side effects of this job bill.  I got the following article from CitiGroup.


Why Is The Tax-Exempt Status Of Municipals Under Assault?

·         The Administration's new Jobs Bill includes an unpleasant surprise for state and local governments

·         Specifically, the bill would cap the value of the tax exemption for high-income investors at 28%. This change would, in our view, increase state and local borrowing costs significantly, and for the first time, create a retroactive change to tax exemption.

·         While this provision is unlikely to be enacted in its current form, it cannot be ignored, because it could come back again as deficit reduction and/or tax reform moves forward.

·         Ironically, one of the purported reasons for this change is to pay for an Infrastructure Bank, a less effective way to support state and local financing than the muni market itself.

·         A key problem for supporters of tax-exempt financing is that the cost of such financing to the Treasury is consistently overstated. A recent study in the National Tax Journal explains why.

Why Is The Tax-Exempt Status Of Municipals Under Assault? 

Summary and Conclusion

On Monday, September 12, the Obama Administration unveiled its new jobs legislation, including for the first time the details of how it would pay for the new costs associated with the program. This section included a potential shock for municipal investors and issuers: for existing and new bonds, the bill would cap the benefit of the tax exemption at 28% for individuals with an adjusted gross income of $200,000 or more and for families with an adjusted gross income of $250,000 or more. For investors in those categories, any tax benefit in excess of 28% would have to be conveyed to the Federal government in the form of a tax. In other words, for an investor in the 35% Federal tax bracket, tax exempt income would now be taxed at 7%.

In our view, this proposal is a serious departure from historical tax policy regarding municipal bonds in that it would be applied retroactively as well as on new bonds. In our view the combination of the new tax and the breach of faith inherent in retroactive taxation would cause borrowing costs for state and local issuers to rise dramatically. We view this primarily as a tax on state and local issuers, NOT on investors, who would simply require a higher borrowing cost on new bonds they purchase, to make up for the tax AND for this new, higher tax risk.

A Shock to State and Local Governments in the President's Jobs Bill.

On Monday, September 12, the Obama Administration unveiled its new jobs proposal, "The American Jobs Act of 2011." The proposal includes a grab-bag of ideas, designed to stimulate job growth, which are likely to create widespread disagreement among economists and members of Congress as to their effectiveness and cost vs. benefit. The bill would provide proceeds for highway repair and construction and other transportation facilities. It would create a new "American Infrastructure Financing Authority"--An Infrastructure Bank-- with the capacity to provide direct loans and loan guarantees to facilitate investment in economically viable infrastructure facilities of regional or national significance.

One new provision, however, was a genuine shock to both investors and issuers in the municipal bond market: As part of the way to pay for all of this, the bill contains a provision which would be likely to severely impair the functioning of the tax exempt market, if enacted. Namely, the bill caps the benefit from receiving tax exempt income and other deductions (including mortgage interest) at the 28% rate. The cap applies to individuals with adjusted gross income of $200,000 of greater and married couples earning $250,000 or more. As we discuss below, we believe that this provision, if enacted would dramatically increase borrowing costs for state and local governments, while in many cases substituting the judgment of a Federal Bureaucracy for the "sort and selection" mechanism provided by the capital markets, both for tax exempts and for Build America Bonds. The following is a relatively brief summary of our initial thoughts on what we believe to be a very poorly designed component of the legislation, which could actually SLOW spending on state and local projects such as infrastructure, rather than accelerating it.

How Would The New Tax Provision Affect The Muni Market?

In our view, there are a number of concerns generated by this provision:

1. The Household Sector is a very large component of the demand for municipal bonds, especially for long-term bonds that are specifically used for infrastructure projects. Working with IRS data for 2009, we find that roughly 45% of muni interest is in the hands of individuals with an adjusted gross income of $250,000 or more and 49% is in the hands of individuals exceeding the $200,000 threshold. This provision would thus, for the first time place a tax on otherwise tax exempt income for a very large number of investors in munis.

2. The size of that tax would be 7% of muni interest for investors in the 35% tax bracket. So, the yield on a bond that had earned 4% tax-free would be reduced by 28 basis points for high-bracket investors, to 3.72%.

3. If the Bush tax cuts were to expire or the maximum income tax rate were otherwise increased, the tax on muni interest would go up, always set at the investor's maximum tax rate minus 28%. In the 39.6% tax bracket, for example, the tax rate on muni interest would be 11.6%, pushing the after-tax yield on the 4% bond in our example to 3.536%. There is another way to view this in terms of comparisons with the taxable bond market: taxable equivalent yield. To use the 4% bond example, the taxable equivalent rate in the 35% tax bracket would be 6.15%. At the 28% rate, it would fall to 5.55%. So you're chopping 60 basis points off the taxable-equivalent yield. To get back to the original 6.15% taxable-equivalent yield under this new regime, the tax-exempt muni yield would have to rise from 4.00% to 4.43%. That's a 43 basis point penalty for issuers on the long-end, even before you add a tax-policy risk premium, and the potential impact of the Bush Tax Cut expiration. When we get back to 39.6% regime, the muni yield would have to rise from 4.00% to 4.77% to make that top-bracket investor indifferent.

4. Clearly, high-income muni investors would require a higher yield on municipal bonds to make up for the new tax, pushing state and local borrowing costs significantly higher, based upon simple arithmetic.

5. However, in our view, the implications of this provision, if enacted, would be far greater than the arithmetic suggests, for several reasons. For one thing, this is the first case that we are aware of where the tax benefit derive from owning municipals is being cut retroactively. There was a strong recognition, throughout Congress, that investors had accepted a lower yield based upon the belief that their muni interest would not be taxed. Therefore, based upon ongoing discussions with Congress, we have always believed that no change in the tax treatment of municipals would be applied to existing holdings. Based upon this new provision-even if never enacted into law-that belief is no longer valid. The Administration has clearly announced a willingness to change the tax status of bonds already issued and owned, something that has NEVER before been considered seriously, that we are aware of. Going forward, the muni market is likely to exact at least a modest tax risk penalty to account for the risk of retroactive taxation, thus pushing state and local government borrowing costs higher to an extent that the math simply does not capture.

6. Finally, it is important to stress that the main cost of this would not fall on muni investors, but on state and local governments. Investors would be made whole by demanding a higher yield on new bonds purchased. Devaluing the muni tax-exemption will simply drive up tax-exempt interest rates. Devaluation of the exemption is a tax on state and local governments, plain a simple. This is not to say that there isn't a cost for investors, but probably not in the way intended:

this provision, if enacted, would drive down the value of bonds already owned by investors. In our view, however, this market effect has no corresponding benefit for the Federal Government.

The Tax-Exempt Municipal Bond Market Is Far Superior To an Infrastructure Bank

In our view, the tax-exempt municipal bond market is far superior to an Infrastructure Bank as a way to provide low-cost funds for state and local projects. The United States has a long history of providing financial support for state and local projects through a Federal Bureaucracy-through the Bureau of Reclamation and the Army Corps of Engineers, through the Federal Highway Administration, and though provisions of ARRA, the 2009 stimulus bill. In virtually all of those cases, a Federal Bureaucracy working independently of the capital markets was a poor substitute for state and local financing. Approval of projects tended to be extremely slow, poorly targeted, and highly subject to political pressures. By contrast, the capital markets-either through tax-exempts or BABs, had extremely important advantages as providers of timely low-cost capital:

·         Projects were selected based upon the willingness of the issuer to undertake the project and make repayment on the debt issued for the project;

·         Issuers had a strong incentive to use proceeds efficiently in order to minimize annual debt service and maintain credit ratings;

·         There was never any incentive to accept a direct federal subsidy for a project simply because the money was there.

·         Projects could be funded and started based specifically upon the project administrator's time schedule simply by going into the capital market to borrow. This is not to say that direct Federal monies provided as grants could not provide an important adjunct to the capital markets. It simply suggests that Federal programs tend to work best when a state or local issuer, not a Federal Bureaucracy, is driving the process, and federal monies are combined with state or local borrowing in order to increase the combined capacity to provided funding for needed projects. The rapid turnaround and better targeting available through such an approach enhances its value as a support for new projects AND for putting project builders back to work. And of course, it avoids the PERMANENT stigma and tax risk premium that would be attached to any provision which goes in and taxes municipal bonds retroactively.

Conclusion: What now?

We believe strongly that the risks of this provision actually being enacted are quite low, IF, and ONLY IF, state and local interest groups remain in contact with their elected representatives in Congress to explain the severe disadvantages of an approach that beggars existing capital market mechanisms in order to provide substitutes to the capital markets. There are other provisions in the Bill that are likely to raise red flags to many lawmakers, such as the cap on the mortgage interest deduction. So, there is likely to be room to work with Congress to eliminate this unappealing change in the market for tax-exempt bonds. Subsidies provided through the capital markets, either through tax-exempts or in combination with BABS with an appropriately targeted subsidy rate, remain the most effective and efficient way, in our view, for the Federal Government to support state and local projects, even if combined with grant money provided at the Federal level.

One Final Note: The Cost of Tax Exemption To The Federal Government

In a sense, supporters of the tax exempt market have always been at a disadvantage because of the high estimates of the cost of tax-exempt financing to the Federal Government. Analysis by the Congressional Budget Office and the Congressional Joint Committee on Taxation has always assumed that if tax-exempt bonds are eliminated, investors would buy taxable bonds taxed at a high marginal rate. A recent study in the June 2011 National Tax Journal takes issue with that assumption1. In the article, the Authors conclude that: "Estimates of the revenue gain from eliminating the income tax exemption for interest paid by state and local governments are sensitive to assumptions about how taxable investors would adjust their portfolios in response to this change. If high-tax-bracket individual taxpayers shun bonds issued by state and local governments when the interest on those bonds is taxable, and if they invest instead in lightly-taxed assets such as low-yield corporate equities, the revenue gain from curtailing the exemption is likely to be substantially smaller than if these investors continue to hold state and local government bonds even after the interest becomes taxable. The extent of household portfolio adjustment depends on the degree to which households pursue tax-efficient investment strategies and on their desire to preserve the diversification that they currently receive from investing in state and local government debt. Shifting from such debt to lightly-taxed equity, one of the portfolio strategies we consider, would add volatility to the returns on household portfolios, since equities have historically displayed more variable returns than tax-exempt bonds. Changes in the mix of assets in household portfolios, offset in our analysis by shifts in the portfolios of non-taxable investors such as pension funds or investors from other nations, would affect the risk properties of the federal government's income tax revenue stream."

In our experience, this type of tax-efficient portfolio substitution is the norm, not the exception, meaning that Federal estimates of the cost of tax exempt financing tend to be overstated by a wide amount.



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