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Local Governments Fear Plan to Tax Bond Interest Threatens Road Funding

House Ways and Means Chairman Dave Camp’s proposed tax overhaul got high marks last week from federal transportation leaders for committing to prop up the ailing Highway Trust Fund, but it is drawing criticism from state and local officials who depend on municipal bonds to finance infrastructure projects.

The Michigan Republican’s plan, which would dedicate $126 billion in new revenue from corporate tax changes to roads, bridges and transit systems, also would expose some municipal bond interest earnings to taxes.

Currently, interest paid on municipal bonds is generally exempt from federal taxes — an indirect subsidy by the federal government that makes the bonds more attractive to investors and reduces financing costs for state and local governments. Under Camp’s plan, a new 10 percent surtax on the very wealthy would apply to municipal bond interest along with other income.

Mike Nicholas, CEO of the Bond Dealers of America, said in a statement last week that subjecting municipal bond interest to the surtax would “negatively impact municipal bonds” by making them less attractive to wealthy investors.

“Ultimately, that translates to higher borrowing costs for state and local governments and capital improvement projects that are delayed, scaled back or cancelled altogether,” Nicholas said.

Under Camp’s plan, interest earned on bonds that agencies issue to refinance existing debt at lower rates also would no longer be tax exempt. Likewise, investors would have to pay taxes on the interest earned on private activity bonds, which are issued by local or state governments to finance projects by private businesses or organizations.

The 2005 surface transportation authorization (PL 109-59) allowed private activity bonds to be issued for the first time to pay for highway and freight transfer facilities. Public-private partnerships, including the Virginia Beltway HOT lanes, have taken advantage of this financing tool.

State and local governments and supporters in Congress have been wary that plans to restructure the federal tax code would target tax-exempt municipal bonds. Hundreds of lawmakers mobilized to preserve the tax exemption last summer, when tax overhaul discussions looked like they might get traction.

“Over the last decade, municipal bonds have funded more than $1.9 trillion worth of infrastructure construction,” the lawmakers said in a letter to House leaders. “This financing went to the construction of schools, hospitals, airports, affordable housing, water and sewer facilities, public power utilities, roads, and public transit. In 2012 alone, more than 6,600 tax-exempt bonds financed more than $179 billion in infrastructure spending.”

The 137 House members who signed the letter spanned the political spectrum, from liberals including California Democrat Henry A. Waxman to conservatives including Minnesota Republican Michele Bachmann.

“Eliminating or capping the current deduction on municipal bonds would severely curtail state and local governments’ ability to invest in themselves,” the lawmakers wrote.

The American Public Power Association, which represents electricity generators, transmitters and providers, said higher borrowing costs would ultimately be “passed onto state and local residents and, in the case of public power utilities, to public power utility customers in the form of higher rates.”

Tom Cochran, executive director and chief executive of the U.S. Conference of Mayors, warned last week that Camp’s proposal to apply the surtax to municipal bond interest earnings would affect interest earned on current bond holdings — not just new purchases.

“This move is economically ill-informed and we believe Chairman Camp is being misadvised on the potential impact of his proposal,” Cochran said. “And worse, the surtax applies to interest earned on both new issues and outstanding bonds.”

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