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Thursday, October 13, 2011
Defeat of Obama Jobs Bill Saves Honolulu Rail Millions
By Andrew Walden @ 3:14 AM :: 8265 Views :: Energy, Environment, National News, Ethics

by Andrew Walden

The debt ridden State of Hawaii, City and County of Honolulu, and the Honolulu Rail project dodged a bullet Tuesday when the US Senate by a 50-49 vote fell short of the 60 needed to cut off a Republican filibuster of President Barack Obama’s so-called “American Jobs Act.”

Little noticed outside financial circles, a tax increase in the bill would have sharply increased the cost of borrowing for state and local governments nationwide.

Under current law investors in municipal bonds receive tax-free interest income. This allows states, counties, and cities to pay below-market interest rates. But Obama’s bill proposed to change this. The Wall Street Journal Sept 13 explains:

The American Jobs Act of 2011, a $447 billion stimulus bill the president submitted to Congress on Monday, would reduce the value of tax deductions on municipal-bond interest for individuals earning more than $200,000 and families earning more than $250,000 per year.

Households targeted by the bill currently receive tax breaks on muni interest based on a 35% tax bracket; under the proposed legislation, that would be reduced to 28% beginning in 2013. The change would mean a household that currently claims a $1,000 deduction would lose $70, or 7%, as their tax savings fall to $280 from $350.

Such a change could erode the value of existing municipal bonds and cause investors to demand higher interest rates to compensate for lost income, straining government issuers and making munis a less-attractive investment option.

"The core issue is that, if you take away the tax exemption on the interest, then the market is going to demand higher yields," said Chris Shayne, market strategist at BondDesk Group. "More tax revenues will be needed to repay the interest on the debt than the principal, so the bottom line is that they can't borrow as much."

The financial plan for Honolulu Rail calls for billions of dollars in municipal bond financing. Hawaii is already the nation’s third most indebted state and Honolulu is the fifth most indebted city.

California’s State Treasurer Bill Lockyear, a Democrat, estimates that the American Jobs Act would have added between $2.7 billion to $7.7 billion to his state’s borrowing costs.

Harvey Golub, former Chairman and CEO of American Express calls it “a jobs bill that boggles the mind:”

…on the one hand (Obama) wants to devote almost half the $475 billion in additional federal spending to states, as he says, to employ teachers, policemen and firefighters and refurbish or build some new infrastructure that states have already decided they don't need or have deemed a low priority.

On the other hand, the bill will add billions of dollars per year to state and local government expenditures by reducing the tax benefit of state and municipal bond issues for taxpayers earning more than $250,000 per year. In total these bonds represent $2.5 trillion in outstanding bonds, with billions more issued each year.

The president obviously believes that tax-free bonds are a benefit to the buyers when, in reality, the benefit accrues entirely to the municipalities that issue the bonds. Because the bonds are tax-free, the issuers pay a lower interest rate—by an amount almost exactly equal to the tax benefit. By reducing the benefit, municipalities will be forced to pay significantly higher rates, increasing their annual debt-service cost. And, since high earners comprise only about one third of the owners of these bonds, lower-rate taxpayers will receive an added benefit from the higher interest paid. In effect, the municipalities will pay more in interest than the federal government will receive in tax payments.

Investors in new bond issues will be unaffected. Those investors that have portfolios of municipal bonds will switch to high-grade corporates or pay the tax from the higher interest payments they'll receive. All of the supposed increase in tax payments from this plan will simply be a transfer from municipal and state governments to the federal government through the hands of investors.

The president also wants these reduced tax benefits to apply to existing bonds, bought under the assumption of receiving the higher tax benefits. It is not very often that higher taxes are applied retroactively, but this will be one of those times. As a result, existing bondholders will see the value of their municipal bonds decline substantially based on the lower tax benefits.

The interesting questions for me are: Did anyone on his economic staff, at Treasury, or at the Office of Management and Budget tell him about this? Did he even ask?

Here’s another question: Did anybody on Hawaii’s Congressional delegation ask?

Both Hawaii Senators Inouye and Akaka voted with those supporting the bill. Senate Republicans have—again--saved Hawaii from her own elected officials.



Jobs Bill Muni Tax:


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