The FY14 budget proposal released by the Obama Administration in April includes language to cap tax deductions for high-earning families – a provision that could drive up municipal bond borrowing costs for local governments. The plan would limit tax deductions and other tax benefits for the top two percent of families to 28 percent of total income. This would include the interest earned by buyers of municipal bonds, which is now exempt from federal income taxes.
Bloomberg News reported earlier this year that municipal bond issuers may have to call as much as $150 billion of debt if the President’s plan to limit income-tax deductions is applied to interest on the bonds. It cited Citigroup municipal bond strategists who said mandatory redemption provisions of some securities could be triggered by a cap that affects the deductibility of earnings for some bondholders. That would mean “substantial” losses for investors, or a “sharp increase in borrowing costs” for localities, according to the report.
The municipal bond market’s value may drop by $200 billion, or about 5 percent, under the proposed deduction cap, according to Bloomberg. Should it be imposed, investors would demand at least a 0.6 percentage point increase in tax-exempt yields to make up for reduced effective earnings.
AMWA is actively participating in Municipal Bonds for America, a coalition working to maintain tax-exempt bonds for community infrastructure investments.