WASHINGTON — Seventeen muni groups are urging members of Congress to reject President Obama’s proposal to place a 28% cap on the value of tax-exempt interest, warning it will hurt the market and that its retroactivity will reverse nearly 100 years of legislative history.

In a letter to House Ways and Means Committee chairman Rep. Dave Camp, R- Mich., and ranking minority member Sander Levin, D-Mich., the groups said the proposal will lead to “higher borrowing costs, less investment in infrastructure and fewer jobs.”

The letter came as Treasury Secretary Timothy Geithner told committee members Wednesday that the 28% cap is “in line with [the president’s] tax reform principles.”

The proposal, which was included in President Obama’s fiscal 2013 budget, would take effect for taxable years beginning after Dec. 31, 2012, and reduce the federal deficit by $584 billion over 10 years. It would apply to single taxpayers with incomes over $200,000 and to married taxpayers filing joint returns with incomes over $250,000.

Once in effect it would apply to interest on all municipal bonds, even those that have been outstanding for years. That would “substantially erode the value of the bonds already in investors’ portfolios,” the letter said.

“This is a burden shift by the federal government in how infrastructure is paid for and ultimately it’s going to be the citizens in our hometowns who will end up paying,” said Lars Etzkorn, program director for federal relations for the National League of Cities, one of the groups that signed the letter. “It may score on the federal government sheet, but if you look at the total budget sheet of this country it’s a wash and will actually cost more.”

Borrowing costs could rise by as much as a full percentage point if the proposal is enacted and it “could amount to an effective 7% tax on otherwise tax-exempt interest for many taxpayers who would be in the 35% tax bracket,” said the letter, which was signed by officials of the Government Finance Officers Association and other groups.

Chris Mier, a municipal strategist at Loop Capital Markets, said since Obama released his budget on Monday it hasn’t affected current prices of municipal bonds. If the budget is passed the market could expect to see some investor adjustment, but it has been met with little enthusiasm on Capitol Hill and will likely not survive, he said.

While the 28% cap angered state and local groups, the president’s proposal to revive the Build America Bonds program encouraged them. Chris Coleman, NLC second vice president, and Mayor of Saint Paul, Minn., was happy to see BABs resurface.

Coleman said the Farmers’ Market Flats, a $13 million housing and retail development in the Lowertown District of St. Paul, was completed this year thanks to BAB financing.

The BAB program was established under the American Recovery and Reinvestment Act but expired at the end of 2010. BABs are taxable, but the Treasury Department pays issuers who sold them during those years a subsidy rate equal to 35% of their interest costs. The administration is proposing a new BAB program, with a 30% subsidy rate for two years and a 28% rate thereafter.

Coleman is concerned about the lower subsidy rate because it could increase the amount of interest cities pay on bonds.

“It’s a difference between getting them done and not getting them done,” he said.  “We’re strapped for cash as it is, so changing those things makes a difference.”

Jennifer DePaul writes for The Bond Buyer.


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