Admittedly, the topic of tax reform generally does not conjure up images of park and recreation projects. They are, however, more intertwined than you may think, and the discussions about tax reform currently taking place in Congress pose a substantial risk for park and recreation projects.
Impetus for Eliminating the Municipal Bond Interest Exemption
Our nation’s budget deficit has reached a record level, and the Congressional Budget Office projects that our deficit will increase at an unprecedented pace over the next 10 years, growing from $642 billion in FY 2013 to $895 billion by FY 2023. It is no secret that our nation’s spending far exceeds the revenue it generates. Due to a dramatic rise in healthcare costs, increased entitlement spending and interest payments on our federal debt, spending is not likely to decrease to a level that will yield a balanced budget. The reality is that restoring our nation’s financial stability will require spending reductions as well as new revenue. Through sequestration, Congress has begun taking steps to curb spending, which means that government leaders are now turning to the tax code as a means of generating more revenue. While revenue discussions always include a recommendation to raise taxes, current discussions also include eliminating various tax exemptions, such as the tax exemption for interest earned on municipal bonds.
Since 1913, when our federal tax system was developed, the federal government has elected to not tax interest income earned on investor funding provided for municipal projects. This public policy was established because the federal government recognized that states and municipalities are the primary funders of our country’s infrastructure, and the ability of state and local governments to finance essential public infrastructure projects such as park and recreation facilities, schools, roads and hospitals was beneficial to Americans and vital to our nation’s sustained economic growth.
Despite the benefits, as national conversations about deficit reduction grew more serious in 2010, government leaders began to explore all options. At that time, the Simpson-Bowles Commission was convened to develop a comprehensive deficit-reduction plan. A surprising recommendation put forth in the commission’s final report was for the federal government to begin fully taxing interest earned on newly issued municipal bonds. While the Simpson-Bowles report as a whole failed to gain Congressional support, the idea of using the municipal bond interest exemption as a means of raising revenue gained traction with the administration, and the president’s FY 2013 and 2014 budgets proposed limiting the interest exemption to 28 percent of the interest earned for new as well as existing bonds.
Risk Associated with Eliminating or Capping the Interest Exemption
The tax exemption on municipal-bond interest helps states and municipalities raise needed capital for infrastructure projects by incentivizing investors to buy municipal bonds. Because these are government securities, the interest earned generally pales in comparison to the interest an investor could earn on other securities, but investors are incentivized to put their money in these securities through the federal tax exemption. As a study conducted by the National Association of Counties reveals, investors have been strongly motivated by the tax exemption, investing $378.9 billion in bonds issued by state and local governments in 2012 alone.
Municipal bonds are the primary means of financing used by state and local governments to fund infrastructure projects. Interest paid to investors is less than the interest the local government would pay using other modes of financing. According to the National League of Cities, local governments save an average of 25 to 30 percent by using tax-exempt municipal bonds versus taxable bonds. This, in turn, allows state and local governments to invest more of the financed dollars into project infrastructure. Because municipal bonds are a low-cost financing option, they are generally well-received by voters, who are willing to use the bonds to pay for a wide array of projects, including conservation and recreation projects. For instance, in 2012, voters approved numerous bond referendums throughout the country that will provide nearly $800 million for conservation projects. This doesn’t include referendums or recreation projects.
If the interest tax exemption is completely eliminated, investors will have less of an incentive to buy municipal bonds, thereby significantly decreasing demand for these securities. If investors do invest, they will seek a greater return on their investment through increased interest as compensation for the taxes they will have to pay. If the tax exclusion for municipal-bond interest had been eliminated in the past decade, it would have cost local governments $495 billion and stalled thousands of essential infrastructure projects, including park and recreation projects. Capping the interest exemption on existing and future bonds would yield the same result, since investors will be exposed to risk that did not exist when they initially invested in the municipal bonds. Either way, the result is fewer projects and increased state and local taxes to pay for the increased borrowing costs associated with the must-have projects funded with municipal bonds.
There has not been an overhaul of the tax code since 1986, and while Congress may have only talked about reform for a number of years, efforts to rewrite the code are already underway, and votes on legislation are already planned. Prior to leaving for the August recess, House Ways and Means Committee Chairman Dave Camp (R-MI) announced plans to mark up legislation in October. Chairman Camp’s timing for the mark-up is no coincidence, as Congress will need to take action to increase our nation’s debt limit, with action likely in November. If Congress fails to pass legislation raising the debt limit, then our government shuts down. Because this is “must-pass” legislation, both parties regularly attempt to use it as a vehicle to advance other agenda items. Due to the political divide that currently exists within Congress, tax-reform legislation will be extremely difficult to pass. For this reason, Chairman Camp has not ruled out possibly trying to link tax reform to debt-limit legislation.
In early July, 138 bipartisan members of the House of Representatives signed a letter urging Speaker John Boehner (R-OH) and Minority Leader Nancy Pelosi (D-CA) to oppose the president’s budget proposal to cap the interest exemption. The number of co-signers on this letter equates to about a third of total House members, strong support for maintaining the exemption in its current form. However, it is not majority support, and the elimination or capping of the exemption is still an option that is being seriously considered.
This is especially true in the Senate. In June, Senate Finance Committee Chair Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT) declared that they will start the drafting process with a blank slate and asked senators to formally submit proposals for what expenditures and exemptions should be included in a reformed tax code. So, senators will have to convince Chairman Baucus and Ranking Member Hatch to add the municipal-bond exclusion (or any other exclusion or deduction) back into the tax code. What’s alarming about this approach is that in February the Senate passed a nonbinding resolution suggesting a cap for the municipal-bond interest tax exemptions.
There is ongoing debate about whether a tax overhaul package is possible before the end of 2014, which is the end of the 113th Congress. Chairman Baucus has announced that he will not run for re-election, so many see tax reform as the legacy he wants to leave. Others cite the cold shoulder Senate Majority Leader Harry Reid (D-NV) gave the blank-slate proposal as an indication that leadership is not behind an overhaul. On the House side, Chairman Camp is considering a run for the Senate in 2014, which could mean that he doesn’t expect a major reform package to make its way through his committee and Congress. Considering that Chairman Camp is one of the biggest tax-reform advocates on Capitol Hill, however, it seems unlikely that he wouldn’t keep trying to at least move the ball forward. In any case, municipal bonds are an important means of financing conservation and park and recreation projects, so we cannot afford to wait and see what happens when we already know elimination or a cap are among the possibilities. NRPA sent a letter to Chairman Baucus and Ranking Member Hatch in July, urging them to include the municipal-bond interest tax exemption in its current form. Your members of Congress in the House and Senate now need to hear from you on this issue. Please tell them to continue to invest in public infrastructure through the municipal-bond interest tax exemption in its current form.
Stacey Pine is NRPA’s Vice President of Government Affairs. Leslie Mozingo of The Ferguson Group contributed to this article.