Tax Reform and its Effects on our Market
A typical tax reform conversation involving the municipal bond market revolves around demand for bonds if personal income tax rates are lowered, thus reducing the appeal of tax-free bonds. This time around, as congress looks to cram through the first real tax reform in 30 years, certain topics have come on to the chopping block that I have never seen considered in my 24 years in the business. As we have witnessed many times under the current administration, these are unconventional tactics in a truly unconventional time.
Included in the House of Representatives tax reform bill is the elimination of private activity bonds (PABs) and any advanced refunding of outstanding bonds. Of all the pork in the proposed reform (write offs for private plane owners, tax cuts for small beer breweries) and all of the obvious loopholes in the system it’s almost unbelievable that these two items ended up on the chopping block. On top of being very surprising, it also speaks volumes to the lack of knowledge our elected officials have to how the municipal market works, who it serves, and who benefits from the tax advantages.
Elimination of Private Activity Bonds
The tax reform package passed by the House last week included the elimination of all private activity bonds (PABs). This was a stranger and puzzling inclusion. I believe, in an attempt to appear tough on billionaires the House didn’t want owners of NFL teams, and other professional sports owners, accessing cheap capital through the municipal bond market to build their shiny new stadiums. As bonds issued to build these stadiums are considered private activity bonds, the baby was thrown out with the bath water. The House of Representatives fails to realize that a great number of private entities, that provide public services, use PABs to fund their expansion and modernization. Some of those entities, not listed in order of importance, include; hospitals, nursing homes, colleges and universities, affordable housing units, toll roads, railroads, and airports. Without access to the low cost capital provided by tax-free municipal bonds these private entities would see an immediate and substantial increase in their cost of capital, and thus their overall operating expense. If you recall, during election season, this congress stumped on a massive infrastructure rebuild and modernization. They promised to rebuild roads and bridges, to modernize air travel and rail travel. They promised to use private and public funds to cover the expense. Oh how far we have fallen from those times. The elimination of PABs is a truly perplexing move if we as a country still wish to improve our infrastructure.
Elimination of Advanced Refunding.
How advanced refunding ended up on the radar of tax hawks is a question we may never know the answer to. For those of you who don’t know what an advanced refunding is, think of it as a city or state being able to refinance their loan at a lower rate, much like you or I would refinance our mortgages. What the elimination of advanced refunding will do is unnecessarily lock our cities and states into high borrowing rates. The Wall Street Journal did a fantastic job explaining them in greater detail this weekend. In a time when interest rates are at historic lows and have been for years it is easy to underestimate the ability to borrow at the lowest possible rate. This is a symptom of cheap money being abundant in the year following the financial crisis. However, when drafting a tax plan it is wise to recognize that this is not the norm and will not be the case forever. There will come a time again where interest rates ebb and flow and are not artificially suppressed. Durning these times we will want our cities and states to be able to borrow when the funds are needed and refinance those loans if interest rates drop, to save the tax payers money ultimately.
Nothing is Final, there is still time to right the ship
Thanks fully the Senate has a better understanding of the benefits, socially, to PABs and their draft does not include the elimination of PABs. The senate will vote this week on their version of tax reform and hopefully PABs and Advanced refundings are spared. As we all weigh the merits of tax reform, it is important to understand how it will affect our lives, and sometimes that requires looking beyond just the headline numbers. With higher borrowing costs, private public partnerships will suffer. Struggling Universities will close their doors at a faster pace than the already are. Airport, and road conditions will deteriorate further as they are forced to expend more resources to pay for borrowed capital. Tax free interest earned on PABs and advanced refundings should never be looked at as a tax break for wealthy investors. It should be viewed as a source of cheap capital for institutions that serve the public.
Senators and congressman from your states are elected to represent you. In drafting and rushing this tax bill, with the elimination of advanced refundings and PABs, it seems that all elected Republicans are ignoring their constituents and voting to progress a party ideal regardless of the effect it has on their constituents.
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Dean Myerow is a municipal bond market asset manager and along with partner, Sean Vesey the team structures institutional and high net worth investor portfolios at Las Olas Wealth Management of NatAlliance Securities LLC.