Alarm sounds over the tax-exemption

Citing rising U.S. debt to GDP ratio and climbing interest rates, a call to action for the public finance community frames the tax-exempt status of municipal bonds as at risk of becoming obsolete.

But the report issued as a municipal commentary by Tom Kozlik, head of public policy and municipal strategy at Hilltop Securities, may not be giving enough credit to the ongoing work that lobbyists and municipal finance advocates continue to do, lobbyists said.

“The evolving political dynamic, the normalization of monetary policy, and the U.S. sovereign fiscal weakening are all increasing the level of policy risk for public finance entities that utilize the tax-exempt municipal bond market,” the report said. “This convergence of risk is intensifying and has the potential to result in the elimination of new tax-exempt municipal bond issuance.”

The report notes that the U.S. debt to GDP ratio has risen significantly since the Great Recession, standing at 98% currently and is slated to increase ever further to 115% by the end of the year, according to current spending levels.

Tom Kozlik, head of public policy and municipal strategy at Hilltop Securities and author of the commentary, noted that the fight over the tax-exemption will likely show its head in 2025


The report also notes that there have been threats to the tax exemption every decade since the 1980s, and even before as “steady rumblings resurfaced when D.C. lawmakers were searching for resources.

Emily Brock, director of the federal liaison center at the Government Finance Officers Association said that since the tax exemption is an expenditure of the federal government, it is always at risk of being subject to austerity measures.

“It’s important that we remain vigilant, but when we sort of raise up our volume, when it’s really time when there really is an imminent threat, you will hear it from Washington, you will hear it from us,” Brock said. “I think it’s important that we understand the strength of what we do have in Washington and the advocacy we do have in Washington,” she added. “But we can always use a little bit more for sure.”

The commentary cites the recent downgrading of U.S. sovereign debt by Fitch to AA+ from AAA as further proof of fiscal risks and that it points to “the expected fiscal deterioration over the next three years, a high and growing general government debt burden and the erosion of governance,” the report said. The Congressional Budget Office also reports federal revenues are down by 10% this year and that federal spending is rising.

Fiscal pressure may intensify in the short term but the threat will likely not surface in this year’s budget battle, which is expected to be a considerable focus when Congress comes back from its August recess on Sept. 5. And it likely will not surface next year due to the Presidential election, making 2025 the year this issue will come to the fore.

“This is also when lawmakers will be preparing for the expiration of provisions from the Tax Cuts and Jobs Act of 2017,” the report said. “By that time deficit reduction will likely become a more meaningful issue even compared to 2010 through 2011.”

But Brett Bolton, vice president of federal legislative and regulatory policy at the Bond Dealers of America, argues this call to action is a little near-sighted and hyperbolic, given that market representatives like himself spend much of their time educating lawmakers and the public on the risks these policy decisions pose.

“All we’ve been doing since advance refunding was taken away in 2017 is educational efforts, trying to inform the lawmakers that they made a policy mistake and it’s time to roll that back,” Bolton said. “Simultaneously, we continue our educational efforts on the importance of the tax exemption and that’s what we spend 99.9% of our time doing.”

“Of course, the deficit situation is incredible and of course, it’s on our radar and munis along with every other expenditure could potentially be on the chopping block,” he added. “We face every day with that being a possibility.”

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