NEW HANOVER COUNTY — One Republican-targeted yet century-old measure of the tax code could be tagged for elimination as the federal government looks to shore up money and pass a new tax bill.
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A 51-page memo leaked from the House Ways and Means Committee identifies different programs — many categorized under health, welfare or energy — that could be modified or eliminated to reduce federal spending. One of these is federal tax exemption for state and local bonds.
The exemption has been in place since the first American tax code was established in 1913 and allows interest accrued on government-issued bonds to go tax-free.
It works like this: A municipality’s governing body votes to pay for a major infrastructure project — schools, bridges, water-treatment facilities — through bonds. Sometimes, such as the case with most general obligation bonds, these must be approved by voters via bond referendum.
The municipality agrees to pay back the bonded amount with interest, but because that interest is tax-exempt for local governments, governing bodies can often secure a lower interest rate, making it easier for the municipality to pay off the debt.
If the tax exemption were removed, it could lead to higher borrowing costs for infrastructure projects. It would then be passed onto the taxpayer and reduce the availability of capital for local governments.
Since 2015, North Carolina had $52 billion in projects financed by tax-exempt municipal bonds, resulting in savings of $1.1 billion for taxpayers in North Carolina, according to the National League of Cities.
The University of Chicago’s Harris School of Public Policy has specifically calculated impacts to North Carolina’s 7th congressional district, which encompasses the Cape Fear region.
The district’s municipalities invested at least $4.31 billion in projects financed by active tax-exempt municipal bonds. It has resulted in an estimated $90.59-million in savings since 2001. Including state government investments, the total savings was $254.50 million.
The NLC has also calculated an additional $6,500 in taxes for each household over the next 10 years should the exemption be removed.
“Each funding is like a layer, it’s a piece of how we build this country,” National League of Cities Manager of Legislative Advocacy Dante Moreno said. “If you take it away and you don’t give us another one, and this one’s been around for 100 years, what are folks supposed to do?”
The National League of Cities is a nonprofit that advocates for the rights of local municipalities on the national stage. Along with the National Association of Counties, United States Conference of Mayors and Government Finance Officers Association, the NLC has been raising the alarm bells to its members about the potential loss of the tax exemption.
New Hanover County Chief Financial Officer Eric Credle has already begun calculating what this would be like for local constituents, as first reported by WECT.
In an email obtained by Port City Daily, Credle said the loss of tax exempt status would be “very detrimental” for county governments.
“The interest rates we pay on new debt would have to be significantly higher, so as to be equivalent to those of taxable investments like AAA rated corporate bonds,” he wrote.
Based on his calculations, a municipal bond that has a tax-exempt interest rate of 4% would need to yield 6.15% to have the same after tax income, whereas a corporation’s needed interest rate would be only 5.06%.
Using a 2% change in the interest rate, the county has $7.3 million currently in bank debt with provisions that allow the interest rate to reset if the tax law changes. Based on this, the county would immediately begin paying $146,000 of additional interest annually on that debt. The amount would go down every year as the principal amount decreases.
Credle wrote the county’s current limited obligation bonds and general obligation bonds would not be impacted, as those rates are set. However, new issuances would be affected.
Credle calculated the county would pay an additional $2 million of interest annually for every $100 million in new bond issuances that are outstanding. As old debt pays off is assumingly replaced with taxable new debt, eventually all $432 million of the county’s current outstanding debt would be taxable, resulting in $8.64 million in additional interest each year.
Port City Daily reached out to the City of Wilmington, Town of Leland, Brunswick County and Pender County to request a similar analysis.
Wilmington’s finance department provided the following: For every $100 million in new bond issuances, the city would pay an additional $2.1 million in interest annually.
Leland spokesperson Jessica Jewell said the town does not “issue bonds at the same rate as other local governments” and thus has not done an analysis, though it would perform one should a future debt issuance be needed.
The question of a better way
In an interview with Port City Daily last week, NLC Manager for Legislative Advocacy Dante Moreno described how concerned the public should be at this point.
“If we’re talking [a scale of] five, five at most, we’re at three-and-a-half, we’re at a four,” Moreno said.
Moreno also made a point to note eliminating the tax exemption would not be a 1:1 exchange of money. The House Ways and Means Committee memo alleges $250 billion in savings, a calculation that goes unexplained; however, the elimination will cost local municipalities $820 billion over that same time period, according to Moreno.
“We assume a number of things will happen if the tax exemption goes away,” Moreno said. “But it’s never gone away, so it’s such a catastrophe in municipal finance that it’s so hard to fully understand what would happen.”
Conservatives and libertarian proponents have been targeting tax-exempt statuses in different ways for several years, often arguing the tax exemptions interfere with free-market principles. However, the Progressive Policy Institute has criticized the exemption by saying it subsidizes tax cuts for the wealthy.
Republicans have also been successful in eliminating other exemptions in the 2017 tax bill — the one that Congress is charged with updating this year — including “advance refunding bonds” that protected the ability of municipalities to refinance their bonds without losing tax-exempt status.
The GOP has even more impetus to identify savings because of the Trump administration’s directive to reduce federal spending, also taking aim at Medicaid and food stamps, two of the biggest pots of money.
Republicans in the House of Representatives passed a budget blueprint to accomplish this in February. It included a $4.5-trillion deficit resulting from an expected extension of Trump’s 2017 tax cuts, which by U.S. Treasury analysis, gives the advantage to the nation’s highest income earners.
The Cato Institute has argued for the elimination of tax-exempt municipal bonds several years before Trump came into power, estimating around $40 billion in savings, not $250 billion as suggested in the Ways and Means memo.
In a 2012 article, Chris Edwards wrote special tax-code carve-outs “often lead to corrupting ties between government officials and private interests,” citing a Washington Post article demonstrating close ties between brokers and dealers in bond agreements. He argues the tax exemptions could be replaced by a reduction in tax rates on capital income.
A 2023 article by Edwards advocated for the removal of the tax exemption based on the corruption count and three others — one being the tax exemption encourages governments to borrow in excess when governments can actually “pay as they go” with current year taxes and user charges.
Edwards also argues that tax-free muni bonds stack the deck against the privatization of facilities like airports, seaports, and transit systems, which is more prolific in European countries. He writes the tax exemption tilts the economy toward government-favored infrastructure, such as jails and sports stadiums, over unsubsidized private infrastructure, such as private manufacturing plants and cell phone systems.
The right-leaning Tax Foundation has also published on the subject, including a 2016 article from Scott Greenberg, tax counsel for the House Ways and Means Committee. Greenberg points out the original exclusion of federal taxes for municipal bonds in the 1913 tax code was due to “concern about the constitutionality of taxing the borrowing power of state and local governments.” He argues this is no longer applicable.
Additionally, Greenberg writes the system is just plain inefficient.
Moreno pushed back on this assessment, stating she would like to see critics of the exemption propose a better plan for local governments.
The Progressive Policy Institute argues for population-weighted block grants, though they come with their own set of problems. Conservatives argue for privatization, though Moreno finds it’s problematic as well,particularly for smaller, more rural communities.
“If you go to the taxable market — which is much larger and in so many different industries — with a $5-million project, no one’s touching that,” Moreno said. “The taxable market deals in hundreds of millions of dollars in projects, not a $5-million police station.”
Moreno states the municipalities could turn to bank loans at much higher interest rates, though she said this isn’t sustainable for banks inundated with requests from the nation’s many municipalities.
In North Carolina’s 7th congressional district, 33 sub-state governments have active tax-exempt municipal bonds. Of them, 14 have less than $30 million of active bonds, with these smaller, less-frequent borrowers representing 42.4% of the district’s total sub-state borrowers.
Despite the policy debate across the political spectrum, Moreno noted municipal bonds in action are largely nonpartisan.
“It’s not like mayors are over-investing in infrastructure and raising everyone’s taxes,” Moreno said. “It’s the communities like … they vote on it, and the vast majority of bonds when they’re voted on, it’s a large margin.”
Reach journalist Brenna Flanagan at brenna@localdailymedia.com.
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