5 incentives from the Muni market to “build back better”

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With Transportation Secretary Pete Buttigieg, a former mayor, leading the charge to deliver on President Biden’s campaign pledge to “build back better,” state and local officials dare to hope that massive new federal infrastructure program pay for improvements to roads and bridges, transit lines, municipal and school buildings, water and sewer systems, and the jobs their construction and operation would create.

But whatever form a congressional deal takes, many, if not most, intergovernmental grants will require the raising of local matching funds with bond issues and their repayment over the life of the new facility. As Congress plays poker on the global package, it must also make it easier and more profitable for states and communities to fund their corresponding shares. The federal jackpot will stay there if the governors and mayors cannot pay their stake.

The traditional vehicle for financing public works at the local level has been tax-exempt municipal bonds, which generally enjoy a lower interest rate than taxable corporate bonds of equivalent quality. In the case of 1988 South Carolina v. Baker, the Supreme Court ruled that this municipal bond tax exemption was only a privilege granted by Congress, not guaranteed by the 10th Amendment. Conservative advocates of municipal finance (and interested underwriters) are keen to preserve this privilege and avoid rocking the boat with alternative funding programs. So don’t be surprised to hear criticism of innovative policy options – especially those that supplant bond peddlers – despite their obvious economic merits. Here are five fiscally effective ideas that should be aired with the White House and the Treasury:


1. Rename the BABs to B4. In 2009, in response to the global financial crisis, Congress gave states and localities the option of issuing their bonds with taxable interest, with a generous pledge to cover 35% of interest charges over the lifetime. of the obligation. They were called Building US bonds (BAB). This program expired in 2010. Economists can demonstrate that a more modest program, but ultimately equivalent in the front A 25 percent federal project grant today could be more economical for many local taxpayers than allowing high net worth investors to avoid taxes on municipal bond interest. No one can argue that the municipal market would not benefit from having some of its bonds taxable, thus expanding the pool of buyers making them attractive to pension funds, IRAs, and foreign investors who don’t care about the money. ‘tax exemption. Call them “Build Back Better Bonds” (BBBB or B4).

2. Go bigger with cheap muni money, now. Municipalities are required to spend bond proceeds within a limited time frame to avoid profiting from taxable short-term money market interest rates against non-taxable municipal bond rates. Offenses risk losing tax exemption. This rule does not make sense in today’s low rate market. In fact, Congress should be encouraging states and communities to issue the largest long-term bond issues they can afford right now, at today’s tight interest rates. Simply remove the pre-2026 investment income restrictions for sales of municipal bonds in 2022 with an average maturity of 10 years or more. Only issuers that fail to innovate by 2026 are expected to lose any investment profit on bond proceeds. This can help accelerate infrastructure spending over the next two years, when the economy is still recovering, and “bank” the proceeds on low-cost bonds for immediate deployment later, when appropriate. Let’s get past construction cost inflation and the inevitably higher interest charges by selling as many munis as possible now, while the Federal Reserve remains dovish.

3. Open the FFB window to Build Better. I have already suggested that the Federal Financing Bank, a branch of the Treasury, could provide lower cost loans to states and state bond banks. In today’s asymmetrical financial markets, taxable treasury bonds carry lower interest rates than AA-rated tax-exempt municipalities, so direct pass-through would be a win-win for federal taxpayers and municipal. For agreements eligible in 2022-2023, the FFB could invoice states for the principal only, with Congress paying the debit interest until 2025. In the current low-rate market, the FFB’s debit interest would then be lower than the tax subsidy currently enjoyed by the tax. -exempt provided. Conceptually, if every municipal bond sold nationwide in 2020 were instead financed in this way using 10-year treasury bills, Uncle Sam’s total cumulative net cost would be less than $ 30 billion over Congress’s standard 10-year budget rating period, or roughly $ 3 billion per year. This is just a rounding error in a multibillion dollar infrastructure plan.

Of course, such a large uninspiring window would put the entire municipal bond underwriting industry out of work, which is sure to invite heated opposition from municipal underwriters and bond lawyers disguised as principled conservatism. A more politically acceptable strategy would allow access to the FFB only for specified priority initiatives. This could include remediation of health and safety risks (including water supply systems and bridges), transit, and green initiatives, while keeping that short FFB borrowing window a limited experience. .

4. Provide tax relief for eligible PPP bonds and dividends. An infrastructure windfall will undoubtedly include locations for public-private partnerships, dubbed “P3” by the profession. Various facility financing projects that can be financed by user fees are ripe targets for such privatization or semi-privatization.

What if private partnerships working in collaboration with public bodies could issue their bonds or preferred shares with payments subject to preferentially lower tax rates? Normally, such partnership income is taxable at higher ordinary tax rates, so the financial incentive would be significant. The advantage here is that the state income tax revenues would not be reduced, but in fact increased compared to the interest on non-taxable municipal bonds. To be eligible, such projects would have to clearly benefit public purposes and reduce carbon emissions while requiring revenue or profit sharing with a public agency.

5. Protect bond investors from inflation. All of this deficit spending worries investors about future inflation, which has pushed interest rates up lately. If future inflation does occur, it is arguably a problem caused by Congress and the central bank, and not by states and communities. To protect fixed income investors, Congress may add inflation protection to Treasury bonds held for at least 10 years by a pension fund or qualified retirement account, or purchased through local banks in as a retail savings bond. Public pension funds can use these useful tools for a variety of portfolio strategies, including sophisticated swap transactions to attach inflation protection to their diversified bond portfolios. Congress could also reimburse an inflation-adjusted principal on maturity of taxable municipal bonds (the B4s described above), which would be ideal investments for pension funds and insurance companies.

Further improvement in tax-exempt municipal bonds could conceptually borrow special repayment privileges attached to low-rate Treasury bonds at the end of the 20th century. They were known as “Floral ties” (as in lilies at a funeral) because they were redeemable at face value for federal estate tax settlement. For zero-coupon-bearing flower bonds – which would pay no interest and be sold at a discount – that are issued before 2024, Congress could reimburse banks in the Federal Reserve system for tax-exempt redemptions to their accumulated value when held by retirees for at least 10 years, or in settlement of inheritance tax. This would allow today’s issuers to take advantage of the lowest lending rates of their lives while protecting investors from future inflation. All of these inflation protections would lower municipal borrowing costs, and if future inflation stays as low as many economists and officials continue to predict, it would be a win-win for everyone.


GoverningOpinion columns reflect the opinions of their authors and not necessarily those of Governingthe editors or the management of.

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