President Barack Obama’s re-election makes his proposal to cap the tax-exemption for interest on municipal debt “more plausible,” said Matt Posner at Municipal Market Advisors.
Obama, in an effort to trim the federal budget deficit, has proposed limiting the value of the muni-bond tax break for higher earners to 28 percent, down from 35 percent. Local governments can borrow more cheaply through the $3.7 trillion municipal market because investors are willing to accept lower yields in return for tax-free income.
“This election makes the administration’s proposal for a 28 percent cap much more plausible,” Posner, an analyst for MMA in Washington, said today at the Bloomberg Portfolio Manager conference in New York. “In the Senate, even before this election, there was bipartisan talk already that this 28 percent idea had legs.”
While the plan may come up during the congressional session that begins next week, it is unlikely to be enacted until fiscal 2014, he said.
Posner and and fellow panelist Peter Coffin, president of Boston-based Breckinridge Capital Advisors Inc., said a better alternative to the cap proposal would be reducing the number of issuers eligible to sell tax-exempt debt. General-obligation bonds and essential-service revenue bonds could remain tax-free, Posner said.
Limiting the exemption is “not a good idea” because investors would view a cap as a “moving target” subject to change by politicians, Posner said.
A cap would disproportionately raise borrowing costs for smaller municipal issuers, Coffin said. Instead, larger entities, those borrowing $250 million or more, should sell taxable debt, shrinking the tax-free market and raising federal revenue, he said.
Posner said he’s seeing “pushback” on retroactively applying a cap to previously issued munis. Because of that, the ceiling would probably apply only to future issuance, he said.