Originally posted at Fox & Hounds Daily.
By Jeff D. Baize.

The “Tax Reform Act of 2014” recently proposed by House Ways and Means Committee Chairman David Camp (R-Midland, MI) would have a devastating impact to California municipalities and state government, as well as nonprofit private hospitals and centers for higher education.

In essence, Camp’s bill would eliminate or seriously reduce the tax-exempt status of an array of municipal bonds that California and other states rely upon to build prisons, housing, energy facilities, airports, colleges, hospitals, schools and thousands of other public and private projects – all in an attempt to provide billions in funding for our already mismanaged federal programs. It would also substantially increase infrastructure costs for nonprofit entities.

And it’s not just the local governments and nonprofit institutions that would suffer – the average California taxpayer would too. If you have a child planning to attend a private university such as Stanford, University of the Pacific or USC, or alternatively attend a k-12 charter academy, Camp’s bill could mean a tuition hike because private schools almost always have a the 501(c)3 designation. Many private hospitals including Children’s Hospitals and hospital systems run by religious orders also have nonprofit status, so they too would be forced to charge patients more for treatment.

How would Camp’s bill do this? Ever since the landmark decision by the U.S. Supreme Court in 1895 that prevented the federal government from taxing debt issued by local government, our federal government has allowed subsidization of local and state infrastructure projects through the use of tax-exempt financing. Internal Revenue Code Section 103 as presently written provides that debt may be exempt from federal taxes when it is determined that the exemption “lowers the burden of local government”.  But Camp’s bill would change all this in a number of ways.

First, Private Activity Bonds (“PABs”), which the bill seeks to eliminate, cover a vast array of municipal financings, not only for single-family and multi-family housing projects or small manufacturing facilities (types of financings that require an “allocation”), but also for certain types of projects involving maritime ports and airports (which don’t require special allocation), as well as financings that benefit 501(c)3 nonprofit corporations, such as colleges and hospitals. PABs are the number one job creation and private sector investment catalyzing tool for economic development, particularly since California’s elimination of redevelopment agencies – so eliminating them would be quite a blow.

Second, Camp’s proposal would prohibit the use of tax-exempt financing for “advance refundings”. Currently under the federal tax code, a local government can issue “advance refunding” tax-exempt bonds to refund a prior issue of tax-exempt bonds that are callable more than 90 days in advance of the date of issue of the refunding bonds — thereby providing debt service savings for local and state governments. Under Camp’s proposal, issuers would have to wait until their bonds are currently refundable before they can issue advance refunding bonds for savings.

Third, Camp’s proposed plan would create three individual income brackets (10%, 25% and 35%) to tax a portion of municipal bond interest, capping at 25% of the value of tax exemption for individuals in the 35% tax bracket.  The surtax would apply to all municipal bonds held, whether new or outstanding. That’s right – it would break the federal government’s promise made to states and municipalities at the time the municipal bonds were sold that interest payments were exempt from federal taxes.  Outstanding bonds held by investors would immediately drop in value.

Fourth, the bill would also do away with “bank-qualified bonds”, which help smaller public entities.  All of this put together will unquestionably dampen demand for municipal bonds, thereby forcing state and local governments to increase their borrowing costs to better compete with taxable corporate bonds on the market. Since taxpayer revenues are used to amortize bonds issued for projects in their communities, higher borrowing costs resulting from Camp’s bill would either increase the tax burden Californians must pay to cover the higher borrowing costs, or suffer cuts in programs and needed infrastructure funded by the tax receipts.

In recent years, credit rating agencies correctly predicted the bankruptcy of a number of California governments and are now telling us we can expect even more. Camp’s bill slams the foot on the gas pedal towards even more municipal defaults.  This bill is designed to make it even tougher for municipalities to meet their infrastructure needs, even while few of them are able to meet all of their current needs given the economic realities of our times.

Pure and simple, this bill is a power play we’ve seen many times in history and is comparable to the days the Vikings would raid villages to usurp their wealth. It is one of the worst ideas we’ve seen yet coming out of our already highly dysfunctional Congress, and that indeed is a low bar under which to slither. Isn’t it time for our federal representatives to really help local governments, nonprofit education and healthcare entities which were all slammed by the Great Recession, instead of proposing damaging measures disguised as tax reform?