27 Nov Unintended Consequences of Changing the Tax Code in Infrastructure, Tax
Congress has a lot on its plate. Tax reform is quickly moving through both chambers of Congress, with a comprehensive federal infrastructure package on deck. Additionally, Congress continues to examine the best way to help the millions of Americans impacted by three historic and devastating hurricanes: Irma, Maria, and Harvey. As it debates these measures, Congress should ensure its disparate efforts work in tandem to support more growth; raise the standard of living; and help those living in Houston, Puerto Rico, and the Virgin Islands.
State and local governments use a variety of tools to fund and finance infrastructure improvements, including private activity bonds (PABs) and municipal bonds. The House-passed tax reform bill would eliminate PABs, and both the House and Senate bills would cap the deduction businesses can take for interest on their debt. Both provisions could seriously hamper private investment in public infrastructure.
Furthermore, both the Senate and House bills contain a provision that would repeal the ability of local governments to advance refund municipal bonds. Local governments use this tool to minimize the costs of financing infrastructure projects, such as water and wastewater facilities.
Take for example a typical municipal bond, paid back over 30 years. A municipality can opt to ‘advance refund’ the bond, essentially paying it off before the typical 10-year refinance window by selling new bonds, usually at lower interest rates. In an advance refunding (as opposed to a current refunding), the bond issuer is able to pay off that old bond issue more than 90 days in advance of its first call date. Just as homeowners do when refinancing a mortgage, borrowers repay their outstanding debt to take advantage of a favorable interest rate environment, reducing their interest payments and freeing up funds for other projects. Bonds can only be advance refunded once during their lifetime.
“By eliminating private activity bonds, the House and Senate are making it more difficult for local governments to meet their ever-increasing infrastructure needs.”
By eliminating this provision, the House and Senate are making it more difficult for local governments to meet their ever-increasing infrastructure needs. According to the Association of Metropolitan Water Agencies, local communities advance refunded 941 tax-exempt municipal bonds between 2012 and 2016, saving local taxpayers $1.36 billion.
The Treasury Department administers the New Markets Tax Credit (NMTC), giving tax credit authority to community development entities—including banks, developers, and local governments—who award credits to investors in exchange for capital. Investors can claim allotted tax credits totaling 39 percent of their investment in an economically depressed area. The credit is claimed in as little as seven years—5 percent in the first three years of the investment and 6 percent in the next four years. In 2016, Treasury awarded $7 billion in tax credits to 120 community development entities among 36 different states, the District of Columbia, and Puerto Rico. Yet the House-passed bill would prevent any further tax credit allocations beyond this year, while the Senate bill is silent on the credit.
Importantly, the NMTC has proven useful in rebuilding areas hit by natural disasters. Following Hurricane Katrina, Congress authorized a $1 billion allowance to be used in affected states. It is credited, for example, with redeveloping 710 housing units in Louisiana and Mississippi after Hurricane Katrina. While it is unclear yet what the total damage from Hurricanes Harvey, Irma, and Maria will cost, one thing is known: impacted areas will need every possible financial tool available to them as they rebuild. According to the New Markets Tax Credit Coalition, the NMTC generated $8 in private investment for every $1 in federal spending. With costs in these storm-ravage areas likely to be in the hundreds of billions of dollars, and given the significant strain on federal resources, this leveraging ratio will prove enormously helpful and economical.
The Historic Preservation Credit (HPC) is a credit of up to 20 percent of the rehabilitation and preservation costs for certain qualifying structures. Supporters argue the HPC has played a vital role not only in disaster recovery but in protecting the nation’s historic buildings and supporting local economic development. According to the National Trust for Historic Preservation, the tax credit leverages $1.20 for every dollar invested. Further, in its annual report, the National Park Service found that in 2016, the HPC generated 109,000 jobs and was responsible for $6.2 billion in GDP.
The House-passed bill would eliminate the 20 percent tax credit for rehabilitating an old or historic structure. The Senate bill, following amendments by Sens. John Kennedy (R-LA) and Bill Cassidy (R-LA), maintained the credit at 20 percent, but required it be spread out over five years, instead of the first year after project completion.
Each provision in the tax code has its supporters and detractors. In attempting to simplify the tax code, congressional decision-makers must make tradeoffs in retaining, reforming, or eliminating individual provisions.
“In attempting to simplify the tax code, congressional decision-makers must make tradeoffs in retaining, reforming, or eliminating individual provisions.”
As BPC Action outlined, some of the provisions currently on the chopping block contribute significantly to other federal priorities, including infrastructure and disaster response. If Congress hopes to achieve both tax reform and boost infrastructure investment, it must bare such tradeoffs in mind and avoid unintended consequences.