A good “loophole”

Where I was raised, the term “tax loophole” had a menacing connotation for working families and often for main street business owners. Certainly with all the talk of comprehensive tax reform, “loopholes” must be on the table for consideration at all levels of government. However, the White House and some members of Congress are championing the elimination of tax-free, local government bonds, feeling that the tax break only benefits rich investors. The tax-exempt bond is a favorite of investors because of the tax consequences and relative low risk involved with these investment vehicles.

Current proposals to hamstring the financing of local infrastructure projects by changing the tax-exempt status of local government bonds would significantly increase the cost of local government to taxpayers. These particular bonds are the country’s most important source of financing vital infrastructure, and they are used to finance everything from multi-billion transportation projects to school expansions. Tax-exempt bonds provide a low-cost and efficient way for cities, school districts, counties and other local government entities to finance much of America’s critical infrastructure.

The best part of this essential tool is that it involves local control without much interference from the state and federal partners — a local flexibility with decisions made almost wholly by local officials who are the closest to the people. The local taxpayers of a community are not often fooled about what local infrastructure is needed and what projects are “bridges to nowhere.” The quickest way for a local official not to be re-elected is to advocate and finance the building of some unneeded “boondoggle.” These locally controlled projects usually realize a maximum return of the taxpayer’s dollar.

In less than a decade, state and local governments financed more than $1.65 trillion of infrastructure investment using tax-exempt bonds.

If a proposed 28-percent cap had been in effect during that time, the borrowing costs to states and localities of these bonds would have increased by $173 billion and would have prevented many infrastructure projects from moving forward. In 2012 alone, more than 6,600 tax-exempt bonds financed more than $179 billion worth of infrastructure projects.

Counties own and maintain 44 percent of the nation’s roadways, 228,026 bridges and almost one third of the nation’s transit systems and airports.

Any change to the taxation status of an often voter-approved debt that is issued by counties risks public works projects and puts into question the nature of the U.S. federalist partnership.

Market analysts have estimated that this proposed tax on local bonding interest would raise state and local borrowing costs by up to 70 basis points (0.70 percent) or more. Because the tax would apply not only to new state and local borrowing but also to all outstanding bonds, investors would be taxed on investment, which they reasonably expected would be tax-exempt as long as they are outstanding — an unprecedented form of retroactive taxation.

Eliminating or even capping the tax exemption on investors would cause them to look for higher-yielding investments and local government would have to offer more interest to lure them back. This simply drives up the cost for local taxpayers to maintain our infrastructure. The burden will be transferred to the property tax. Changes to the tax exemption would raise costs for financially strapped state and local governments, and they would result in less investment in infrastructure, particularly at a time when jobs are scarce and the physical state of public infrastructure is deteriorating.

This “loophole” is a good deal for taxpayers and should remain a tool for strategic infrastructure financing.