Preserving State and Local Tax-Exemption

It’s been another anxious week in financial markets as the news of China’s AI upstart, DeepSeek, rattled the high-tech industry Monday morning, and investors leaned into safe havens, causing bonds to rally.  Then on Tuesday, the president’s Office of Management and Budget caused chaos and confusion with a memo ordering federal agencies to “temporarily pause all activities related to obligations or disbursement of all federal financial assistance.”  The directive was temporarily blocked by a federal judge Tuesday afternoon, and then rescinded Wednesday morning as backlash mounted and roughly two dozen state attorneys general filed lawsuits against the administration.  That was followed by the much-awaited FOMC meeting in which the Committee voted unanimously to keep the fed funds rate at 4.25-4.50% and indicated that they are in no hurry to cut rates.  The somewhat hawkish stance led to a slight sell-off in Treasuries but for the most part was as expected, and the bond market closed the day with little change. 

In the municipal bond arena, the hot topic has been how tax-exemption will be impacted as key provisions of the Tax
Cuts and Jobs Act (TCJA) begin to sunset in 2025.  Should Republicans be successful in making the cuts permanent,
key provisions impacting municipal bonds include:  


       ·          The continued prohibition of using tax-exempt bonds for advance refunding

·          The corporate tax rate remaining at 21%

·          The repeal of the 20% corporate alternative minimum tax (AMT)

·          State and Local Tax (SALT) Deduction limitation permanently capped at $10,000 

·          Elimination of certain tax credit bonds

Of more concern to muni advocates, a 50-page list of budget reconciliation targets lists the outright elimination of 
tax-exemption as an option.  The estimated cost, or taxes not collected by the federal government due to the tax 
exemption, has varied in estimates ranging from $270-400 billion over a 10-year period.   That cost would be shifted
to municipalities by forcing them to issue taxable bonds at significantly higher interest rates.  The Government 
Finance Officers Association estimates that the elimination of tax-exemption would actually raise state and local 
borrowing costs by over $800 billion in the next 10 years, a cost that would be passed on to local residents.   
Eliminating the exemption would severely impact infrastructure investment and curtail economic growth.  

This is not the first time that tax-exemption of municipal bonds has been threatened.  In the past, both sides of the
aisle have appreciated the importance of improving infrastructure so the threat has not grown legs.  We hope that 
will be the case once again.