Hilltop Securities
Looking into the fixture of tax policy reveals a cloudy crustal ball holding political friction, hard questions about the national debt and the incoming administration’s ability to govern, as muni market thought leaders are mainly focused on the costs of expensive tax cuts.
“Lawmakers will need enhanced pay-fors, putting a substantial target on the municipal bond tax exemption,” said Tom Kozlik, managing director, head of public policy & municipal strategy for Hilltop Securities.
“I think there is a 50% or greater chance the municipal bond tax exemption will be significantly curtailed or even completely eliminated in 2025.”
The concern stems from precedent as President Trump’s last tax reform bill, the Tax Cuts and Jobs Act, put a cap on the state and local tax deduction and eliminated the advance refunding of tax -exempt bonds.
The value derived from cutting advance refunding remains in dispute as efforts to restore it have stalled.
“One of the things that baffles our community is why doesn’t advance refunding sunset along with those other provisions such as SALT?” said Emily Brock, director, federal liaison center, Government Finance Officers Association.
The size of the SALT deduction has remained an active issue thanks to lawmakers of both parties from high-tax states such as New Jersey who would like to see the current cap repealed or adjusted.
The cap limits deductions to $10,000, but many states have instituted workarounds that help businessowners avoid the cap entirely. The future is fraught with political peril.
“I think that President-elect Trump mentioned doubling the cap, and that’s going to upset three quarters of the Republican caucus,” said Brett Bolton, VP of federal legislative and regulatory policy, at the Bond Dealers of America.
“I assume that the SALT Republicans will push back hard enough that a bill can’t pass without some kind of change next year.”
Republicans and Democrats mostly agree on TCJA provisions that provide tax relief to working class families.
“The ASA supports extending several key provisions of the TCJA, particularly those that benefit working families and investors,” said Chris Iacovella, CEO of the American Securities Association.
“We also believe that the municipal tax exemption should continue its role in supporting projects that benefit communities in blue and red states and that is non-negotiable.”
During the campaign Trump made promises about not taxing tips or overtime wages which would also reduce tax revenue.
The cost of extending the TCJA has been estimated by the Congressional Budget Office at around $4 trillion over ten years and increase the federal deficit by nearly $5 trillion by 2034.
The CBO is a non-partisan government agency that provides budget and economic analysis to Congress, but the warnings appear to be falling on deaf ears.
“There is a high percentage chance TCJA will be extended and expanded,” said Chuck Samuels, member at Mintz Levin and counsel to the National Association of Health and Educational Facilities Finance Authorities. ”Along with tariffs it’s the core of the Trump economic program and the majority in congress is well in line.”
The possibility of more tariffs has been suffering from withering criticism by most economists. There has also been discussion about turning away from income tax and towards a value added tax system that may other countries are already using.
”A major question is what new policy will make it into the sweeping tax bill,” said Emily Cadik, CEO, Affordable Housing Tax Coalition. “Our focus is how affordable housing may fit in.”
Affordable housing ties back to Low Income Housing Tax Credits which rely on a capped amount of Private Activity Bonds that are issued each year.
PABs allow private entities to access tax exempt financing to fund a wide variety of infrastructure projects and are also a favorite target of lawmakers searching for ways to replace the lost revenue.
“There’s a chance that Congress may look to restrict tax-exempt bonds, in particular private activity bonds,” said Johnny Hutchinson, partner at Nixon Peabody.
“The theory is that if Congress eliminates tax-exempt financing for a particular type of project, these projects will still go forward, and will still be financed, but will be financed instead with taxable sources of funding.”
Qualified private activity bonds, which can be used by nonprofits to finance infrastructure, showed up in a recent
The report excluded qualified PABs used in conjunction with financing affordable housing. PABs are deployed in health care facility financing and by issuers in higher education, which are also on the target list.
“My broader concern is that there’s a lack of understanding about private activity bonds,” said Bolton. “If they want to go after healthcare or higher-ed, they’re just going to lump all private activity bonds into one grouping.”
The size of the Internal Revenue Service budget is another area of interest for cost cutters, even though many experts note that boosting IRS enforcement efforts pays for itself.
The IRS received an $80 billion budget windfall courtesy of the Inflation Reduction Act but then lost $20 billion during the debt ceiling negotiations in 2023. More cuts could be coming as the agency’s current commissioner Danny Werfel is likely to be replaced by presidential appointee Rep. Billy Long, R- Mo.
“I’ve heard numerous accounts from accountants and business leaders about the IRS struggling with a significant backlog, unable to process their workload efficiently,” said Kozlik.
“These outcomes ripple through to state and local governments nationwide, potentially impacting their finances. However, increased IRS funding is unlikely to be a politically popular topic in 2025.”
Many issuers find themselves dealing with the IRS for the first time this year thanks to changes to the “direct pay” or “elective pay” system that allows non-profit organizations including state and local government to convert clean energy credits into cash refunds.
“The tax credit provisions in the Inflation Reduction Act of 2022 have absorbed all of Treasury’s time and attention since its enactment,” said Hutchinson. “We are still waiting for clarifying guidance on how those provisions mesh with tax-exempt bond financing and other aspects.”
“If there is reduced IRS funding that could potentially impact the program,” said Brock. We are very much not interested in seeing administrative supply in that department go down. Elective pay is a brand-new process.”
Change is coming to some of the key committee leadership positions including the House Financial Services Committee where Partick McHenry R – N.C. is retiring and being replaced by current Committee Vice Chairman French Hill, R- Ark.
“French Hill overseeing House Financial Services is great,” said Brock. ”He’s tuned in with the municipal finance community. We always like to see rural people or people who have served in state or local leadership positions, because they get bonds.”
Sen. Mike Crapo, R- Idaho, who is expected to move from the ranking member to the chair of the Senate Banking Committee also earns high marks with the muni community.
The winds of change can’t be stopped but lawyers, lobbyists and policy makers are already busy prepping for what’s on the horizon, especially the possibility of eliminating tax-exempt municipal bonds.
“We continue to remain concerned,” said Bolton. We’re using that concern and turning it into an opportunity to further educate members of Congress and their staff on the importance of the tax exemption to ensure that in this discussion and going forward, the tax exemption is not targeted as a pay-for.”
“Our coalition has never been stronger,” said Brock. “Many people, and issuer organizations, have not relaxed since 2017. The first and foremost thing on that list is preservation of the tax exemption at all costs.”
“I think the municipal bond tax exemption has a target on its back,” said Kozlik. ”It’s likely to be used as a pay-for in 2025 unless public entities and state and local governments vigorously advocate and defend it.”