Municipal bond experts opposed the proposal to remove longstanding municipal bond tax exemptions during a Securities Industry and Financial Markets Association conference on September 27.
The proposal would remove the tax exemptions for investors with annual incomes of $200,000 or more.
“Ideas out there have created this feeling that the municipal tax exemption, rather than being a help to the state and local governments, somehow gives a tax expenditure rather than an exemption to get infrastructure done,” said David Madigan, chief investment officer at Breckinridge Capital Advisors.
“And the impact I think this has on small issuers is huge,” he added.
Small issuers would be less able to finance infrastructure projects if the tax exemption is removed because of lower demand for munis, Madigan said.
George Friedlander, managing director and senior muni bond strategist at Citi, was also critical of the idea that state and local governments could function well without the tax exemption.
“I note that even under [Build America Bonds] with a 35 percent subsidy, break-even costs between the tax exemptions and [Build America Bonds] was around nine years by the end,” Friedlander said. “For smaller issuers it was further out on the curve than that.”
Friedlander said removal of the exemption would increase the level of debt service per million dollars of bonds issued, thus lowering the capacity to fund projects for a given level of borrowing.
Concern over the proposal is partially alleviated by the belief that a retroactive removal of tax exemption for munis would not pass a congressional vote.
“I think our own view is that the likelihood that [the retroactive tax] will be introduced is pretty close to zero,” said Alan Hart, managing partner and chief investment officer at Cedar Ridge Partners.
“I can certainly see it being implemented for future issuances that would be consistent with prior transitions in the tax policy,” he added.
Panelists expect the tax exemption on muni bonds to be a point of contention for the foreseeable future, even though they are confident the proposal will halt at the House of Representatives.
“I’m a firm believer that when bad ideas start in Washington they tend to continue to roll,” Madigan said.
If Madigan’s right about muni bonds, then traders, high income investors and state and local governments should hope he’s wrong about Washington.