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State and local governments use municipal bonds to finance public infrastructure investments that enable their communities to function and thrive. Tax-exempt municipal bonds have financed $2 trillion in new investments in infrastructure over the last decade, including $96 billion in new investments in electric power generation, transmission, and distribution. On February 13, 2018, Municipal Finance Caucus Co-Chairmen Randy Hultgren (R-IL) and Dutch Ruppersberger (D-MD) introduced H.R. 5003, a bill that would reinstate the ability of state and local governments to issue tax-exempt advance refunding bonds—a useful tool in refinancing outstanding debt that was prohibited by the 2017 Tax Cuts and Jobs Act. The American Public Power Association (APPA or Association) strongly supports H.R. 5003 and encourages members of Congress to co-sponsor the bill. The Association also strongly believes Congress should look for other ways to improve tax-exempt financing and reject any proposal to further limit or restrict tax-exempt financing.
Background and History
State and local governments have issued municipal bonds to finance long-term projects for centuries. Today, there are $3.7 trillion in municipal bonds outstanding, more than $200 billion of which finance electric power related investments. These include investments in power generation, distribution, reliability, demand control, efficiency, and emissions control—all of which are needed to deliver safe, affordable, and reliable electricity.
In addition to infrastructure for public power utilities, these bonds finance roads, bridges, sewers, hospitals, libraries, schools, town halls, police stations, and every other sort of government-purpose investment made by state and local governments. In fact, nearly three-quarters of the core infrastructure investment in the U.S. is financed by state and local government bonds.
Since the creation of the federal income tax in 1913, interest on government purpose municipal bonds has been exempt from federal income tax, just as federal bonds are exempt from state and local tax. Since then, the federal government has taken steps to regulate municipal bonds—for example, requiring issuers to register bonds for the interest to be exempt from federal taxation, and to tax the interest on bonds determined not to be for governmental purposes. More recently, Congress blocked the issuance of tax-exempt advance refunding bonds as part of H.R. 1, the Tax Cuts and Jobs Act of 2017. Fortunately, Congress did not overturn decades of precedent—and perhaps face a Supreme Court challenge—by changing the underlying tax treatment of government purpose bonds.
Strengths and Benefits of Municipal Bonds
The municipal bond market gives close to 42,000 governmental issuers access to investors. This is particularly important to smaller towns, counties, and publicly owned utilities that issue municipal bonds. Outside of municipal bonds, state and local governmental entities—including public power utilities—have limited means to raise funds for their communities’ capital needs.
The federal tax exclusion of bond interest means issuers of all sizes can finance their investments affordably. For example, APPA estimates that a $25 million project would have cost $9 million less to finance if it had been financed with tax-exempt debt. A $250 million project would have cost roughly $79 million less. These savings result in more critical investments in infrastructure and essential services by state and local governments and lower costs for the services they provide. Also, municipal bonds are ideally suited to finance capital-intensive and long-lived public infrastructure, such as the assets of a public power utility, with the cost of investments repaid over time by the customers who use the infrastructure.
Investors purchase municipal bonds in part because of tax considerations, accepting a lower rate of return because the interest is exempt from federal income tax. Municipal bonds are also valued for their ability to generate a steady stream of revenue for fixed-income households. Individual households are the investors in over 70 percent of municipal bonds. Nearly 60 percent of this household tax-exempt interest is earned by taxpayers over 65 years old. In 2012, 48 percent of all municipal bond interest paid to individuals went to those with incomes of less than $250,000.1
Recent market performance and the “flight to quality” underscore that municipal bonds are also valued as stable financial investments. Now more than 200-years old, the U.S. municipal bond market is well-established, with a robust and comprehensive federal legislative and regulatory system that protects investors. Likewise, municipal bonds themselves are, generally secure investment vehicles: the default rate for investment grade municipal bonds is far less than 0.1 percent, a fraction of the default rate for comparably rated corporate bonds.
Congressional and Administration Actions
In a substantial victory for public power, the Tax Cuts and Jobs Act retained the underlying tax exemption for municipal bonds. Unfortunately, however, the act prohibited the issuance of tax-exempt advance refunding bonds and tax credit bonds. These newly enacted limitations were included to raise $18 billion to offset other tax cuts in the act. Advanced refunding bonds allowed states and localities to refinance debt and reduce costs for their communities. The act still allows issuers to issue tax-exempt current refunding bonds—i.e., refunding bonds issued within 90 days of the refunded bond’s redemption—but repeal of advance refunding bonds needlessly hinders public power utilities’ ability to refinance existing debt at the lowest possible cost to customers.
To remedy this misguided move, Municipal Finance Caucus Co-Chairmen Randy Hultgren and Dutch Ruppersberger introduced H.R. 5003, a bill that would reinstate the ability to issue tax-exempt advance refunding bonds.
House Ways and Means Committee Chairman Kevin Brady (R-TX) has said he is working on tax reform “phase two.” While the chances for another wholesale reform of the federal income tax are small, the federal government faces significant fiscal challenges and the demand for new revenue could be great. Likewise, interests seeking to increase the cost of publicly financed investments—in part to force “smaller” government, and in part to make privatization more cost competitive—remain engaged and will seek other legislative opportunities to undermine or erode the current-law tax exemption for municipal bonds.
American Public Power Association Position
APPA believes that tax-exempt municipal bonds are the single most effective tool for financing investments in public infrastructure, including the generation, transmission, and distribution used to serve public power utility customers. As such, the Association believes the federal tax exclusion for municipal bond interest should not be limited or replaced. APPA thanks lawmakers who made this case during the tax reform debate and ensured that the underlying tax exemption for municipal bonds remains intact. In addition, the Association also strongly supports enactment of H.R. 5003 to reinstate advance refunding bonds and encourages members of Congress to co-sponsor the bill. Finally, APPA strongly believes Congress should look for other ways to improve tax-exempt financing, and reject any proposal to further limit or restrict tax-exempt financing.
1 Internal Revenue Service, “Statistics of Income—2010: Individual Income Tax Returns” (2012).
2 Senate Republican Policy Committee, “Tax Reform’s ‘Simplicity Dividend,’ (June 13, 2017); https://www.rpc.senate.gov/policy-papers/tax-reforms-simplicity-dividend.