WASHINGTON — Tax reform legislation is unlikely to move forward this year, but municipal bond market participants shouldn’t think that the threat to the tax exemption for munis is gone, observers in the market said.

“We shouldn’t assume that we’ve dodged a bullet,” said Michael Decker, managing director and co-head of municipal securities for the Securities Industry and Financial Markets Association.

There is unlikely to be significant movement on tax-reform legislation during the rest of 2013, market participants agreed. Although House Ways and Means Committee Chairman Rep. Dave Camp, R-Mich., wanted to hold a committee vote on a tax reform bill by the end of the year, the chances of this happening appear to be slim. On the Senate side, Finance Committee Chairman Sen. Max Baucus, D-Mont., could release discussion drafts on some areas of tax reform as early as this week, those are expected to focus on international taxes, tax administration  and the cost recovery method of tax accounting..

But members of Congress continue to talk about the work they are doing on tax reform, Decker said.

“It’s clear that tax reform is still on the agenda,” he said.

Bill Daly, director of government affairs for the National Association of Bond Lawyers, said that the pressures for tax-rate reduction, deficit reduction, and the desire to look in detail at the tax code remain. He noted that the formal process for the 1986 tax reform was a multi-year effort.

“This is a long-term process,” Daly said.

Susan Collet, senior vice president of government relations for Bond Dealers of America, said that Congress will at some point have to make major decisions about spending, entitlement reform and tax revenues. When lawmakers make these decisions they will look at published white papers and proposals, whose suggestions have included changes to the tax exemption for munis.

“We know this is still on the menu,” she said.

Collet added that tax reform legislation could be pushed to 2015, or the next Congress, because the House members are up for reelection in 2014 and they will want to emphasize high-profile issues like the rollout of the Affordable Care Act.

Decker said that while the midterm elections will be “a hurdle” for tax reform, there will still be activity on the Hill about tax reform in 2014 and the issue of the tax exemption for munis will be a discussion point.

A lobbyist who represents a number of financial services clients said he thinks comprehensive tax reform is politically difficult and unlikely in 2014 but that business-tax reform only has a better chance of happening next year and could affect munis.

Camp has talked about lowering the top individual and corporate tax rates to 25% while keeping tax reform revenue-neutral. In order to do this, tax reform would have to “severely constrain tax preferences,” Decker said. Therefore, there is a risk that lawmakers will try to curb the ability of issuers to issue tax-exempt bonds, the ability for investors to earn tax-exempt interest, or both.  “We shouldn’t back off on our advocacy,” Decker said.

John Buckley, former Democratic chief tax counsel for the House Ways and Means Committee, said that the tax-exemption for qualified private-activity bonds is especially at risk of being changed under any reform. He also said that it’s clear that the deduction for state and local taxes would be repealed under any House legislation on tax reform for individuals. A repeal of that deduction would hamper state and local governments’ abilities to raise revenues and therefore discourage bond financings. “The tax-exempt bond community needs to take a slightly broader focus,” he said.

Naomi Jagoda is a reporter for The Bond Buyer.

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