By Yali N’Diaye

WASHINGTON (MNI) – The Obama administration’s fiscal year 2013
budget proposal would lead to lower tax exemptions for high income
people investing in municipal bonds, likely leading to higher yields in
the muni market and lower supply, according to SIFMA.

The proposal would translate into higher borrowing costs for
municipal issuers, National League of Cities Program Director, Finance
and Economic Development, Lars Etzkorn also told Market News
International.

Ultimately, he said, that would cost jobs through the decrease in
the number of projects being financed.

That being said, Etzkorn does not anticipate that the president’s
budget will be adopted in its whole, seeing no reason for such a
proposal to gain more traction that it has in the past attempts.

In fact, Moody’s told MNI earlier that chances for the budget plan
to be adopted as proposed are “small,” without, however, specifying
which portion of the budget would be particularly unlikely to be
adopted.

The administration is proposing to “reduce the value of itemized
deductions and other tax preferences to 28% for families with incomes
over $250,000.”

“Currently, a millionaire who contributes to charity or deducts a
dollar of mortgage interest, enjoys a deduction that is more than twice
as generous as that for a middle-class family,” the FY 2013 budget
proposal reads.

“The proposal would limit the tax rate at which high-income
taxpayers can reduce their tax liability to a maximum of 28%, affecting
only married taxpayers filing a joint return with income over $250,000
(at 2009 levels) and single taxpayers with income over $200,000,” it
continued.

This limit would apply to tax-exempt interests among others.

“The proposed limitation would return the deduction rate to the
level it was at the end of the Reagan Administration,” the budget
proposal added, estimating it would reduce the deficit by $584 billion
over a decade.

The proposal was floated in the fall as part of the jobs
initiative, “and frankly we are disappointed that the provision was
included in the budget,” Securities Industry and Financial Markets
Association muni expert Michael Decker told MNI.

Because it is retroactive and would apply to outstanding bonds, he
said, “it would have the effect of reducing the value of bonds in
investors’ portfolios,” while imposing “significant tax liability on
those investors.”

For new bonds, he said, it would raise borrowing costs for states
and local governments.

“So it would hit investors with regard to bonds already outstanding
and states and local governments with regard to new financing.”

Issuers, don’t have a lot of alternatives, however, than issuing
capital market debt.

“They will still continue to issue some bonds,” Decker said, “it
will be more expensive, so they’ll have to issue less” since their debt
capacity is limited, ultimately reducing supply in the muni market.

Overall, the after-tax return to investors would not change that
much, although the pre-tax yield would have to rise to compensate
investors above the income threshold for the amount of tax they will
have to pay on that tax exempt bond interest.

For investors in the 35% tax bracket, capping the deduction at 28%
amounts to a 7% tax on the municipal bond tax interest, the muni expert
said. “So yields will have to adjust to compensate those investors for
that 7% tax.”

In addition, the top marginal tax rate is scheduled to rise at the
end of the year as part of the end of the Bush-ear tax cuts to 39.6%
from 35%, which would amount to an 11.6% effective tax rate on
tax-exempt interest. “Yields would have to rise that much more,” Decker
concluded.

In a statement earlier, the Bond Dealers of America said, “We’re
disappointed the Obama Administration has proposed cutting the value of
the municipal tax exemption at this critical juncture when cities and
states, especially smaller ones, are still struggling.”

“While we’re pleased the Administration has chosen to maintain a
vibrant bond market by proposing direct-pay alternatives that lower the
cost of municipal finance while increasing the diversification of
investors in the market, we strongly believe cities and states need a
strong tax-exempt program to fund critically needed infrastructure
projects at a reasonable cost.”

** Market News International Washington Bureau: 202-371-2121 **

[TOPICS: M$U$$$,MAUDS$]