Muni Credit News February 5, 2015

Joseph Krist

Municipal Credit Consultant


The $4 trillion fiscal 2016 budget request unveiled by President Obama on Monday includes several proposals for the municipal market to chew over. They include: a six-year, $478 billion transportation infrastructure plan; the creation of tax-exempt qualified public infrastructure bonds; America Fast Forward direct-pay bonds; and an increase in the annual issuer bond limit for bank-qualified bonds.

On the negative side, the idea to limit the value tax-exempt bond interest to 28% of a taxpayer’s income was again included. A new proposal to eliminate the use of tax-exempt bonds to help finance professional sports stadiums was also included.  As expected, the budget proposes the creation of tax-exempt QPIBs, which would not be subject to volume caps or the alternative minimum tax. They would however, have to comply with other private-activity bonds requirements, such as having to obtain public approval.

QPIBs could be issued beginning in 2016 for airports, docks and wharves, mass commuting facilities, water furnishing and sewage facilities, solid waste disposal projects, and qualified highway or surface freight transfer facilities. Projects financed by QPIBs would have to be owned by a state or local governmental unit and would have to serve a public use or be available on a regular basis for general public use. QPIBs could replace certain PAB categories or could be issued in addition to them. The revenue loss associated with the new bonds would increase the deficit by $4.83 billion from 2016 through 2025, according to the budget.

As anticipated, the budget would increase the issuer annual cap to $30 million from $10 million for bank-qualified bonds. Banks could buy the tax-exempt bonds of issuers who reasonably expected to issue less than $30 million of munis during the year. Also proposed was a change to the 2% de minimis rule for financial institutions to include banks. That provision would allow banks to deduct 80% of the cost of buying and carrying tax-exempt bonds, to the extent that their tax-exempt holdings do not exceed 2% of their assets. Banks currently are only able to take advantage of that 80% write-off when purchasing bank-qualified bonds.

The president proposed expanding a little-known program called Qualified Public Education Facility Bonds. First authorized in 2001, issuance is currently capped at the greater of $5 million or $10.00 per capita. The program has not been used much, if at all, because of its problematic requirement that an educational facility be both part of a public elementary or secondary school and owned by a private, for-profit corporation engaged in a public-private partnership with a state or local government. The proposal would eliminate the private corporation ownership requirement and subject QPEFs to state PAB volume caps. Once more the administration renewed its idea for a 28% cap on the value of tax-exempt bond interest, including for bonds already issued, beginning in 2016. Dealer groups complain this would be a tax on municipals.

Obama’s proposed fee of seven basis points for banks, broker-dealers and other financial institutions with worldwide assets of more than $50 billion was also criticized.

The budget once again calls for the creation of a permanent, taxable direct-pay America Fast Forward bond program, with Treasury making subsidy payments to issuers equal to 28% of their interest costs. AFF bonds could be used to finance projects that could be financed with PABs or QPIBs as well as governmental capital projects or current refundings of bonds associated with such projects. They could also be used for working capital financings and projects for 501(c)(3) nonprofit entities.


The President’s budget proposal for FY 16 included provisions that would cause manufacturers based in the states to no longer be able to avoid Federal taxation of income through U.S. territories and foreign countries. Currently, companies can avoid the taxation by establishing subsidiaries in territories and other nations. The 35% corporate income tax is not due unless the parent company receives the earnings from the subsidiary.

Under the provision known as repatriation, the President calls for  taxing the income at a 19% rate. Also proposed  is a one-time rate of 14% for earnings that have been kept out of the United States for past years through the first year of the new taxation. The President, additionally, also proposed lowering the rate on corporate income from the States to 28%. The 19% rate would be reduced for taxes paid locally and investments in operations such as manufacturing facilities.

The tax avoidance strategy is used by most of the companies based in the States that have manufacturing operations in Puerto Rico. Puerto Rico could theoretically be the beneficiary of most of the 19% rate under the Obama proposal but the commonwealth government has entered into contracts with manufacturing operations that lower its taxation of their income to a few percent at most. Because the contracts prevent the Commonwealth from increasing the tax, it has also imposed a four percent excise tax on parent company purchases of the products of their subsidiaries. The combined taxation, however, is still far short of the 19%.

The tax proposal was the only real change in the direct federal impact on Puerto Rico in the Obama budget. An annual list of State, territory, and freely associated state shares of selected programs estimated that Puerto Rico would receive $4.02 billion in Federal Fiscal Year 2016 vs. $3.93 billion this fiscal year. The increase is smaller than the increase for all jurisdictions but in line with the Commonwealth government’s usual share. That share for Federal Fiscal Year 2016 is .71% of the programs. The share is small compared with what it would be if Puerto Rico were a State and treated equally with the other States in all programs. The territory about 1.1% of the nation’s population.


In his Executive Budget for the FY 2016-FY 2017 biennium, Governor Kasich recommends GRF appropriations of $35.3 billion in FY 2016 (a 12.5% increase over estimated FY 2015 spending) and $37.0 billion in FY 2017 (a 4.8% increase over FY 2016). The Governor’s recommendations for all funds total $68.5 billion in FY 2016 (a 2.0% increase over estimated FY 2015 spending) and $70.2 billion in FY 2017 (a 2.5% increase over FY 2016). Medicaid is the single-largest program in the state budget, with recommended GRF appropriations in FY 2016 of $18.5 billion (21.4% above FY 2015 estimated spending levels) and $19.6 billion in FY 2017 (6.2% above FY 2016 spending levels). These appropriations include the federal share of the program, which makes up approximately 68% of the total. State share appropriations total $6.0 billion in FY 2016 (4.4% above FY 2015 estimate) and $6.3 billion in FY 2017 (6.1% above FY 2016).

The centerpiece of the budget plan is tax reform. The Governor’s tax reform proposal, would reduce state revenues by $367 million in FY 2016 and $443 million in FY 2017. The proposal would cut all marginal income tax rates by 23% and create a new small business deduction. To help pay for these significant cuts, offsetting revenues would be generated by increasing the state sales tax rate from 5.75% to 6.25%, subjecting a subset of services to the sales tax, reducing the motor vehicle trade-in allowance, increasing the commercial activity tax (CAT) rate, and increasing tax rates on cigarettes and other tobacco products (OTP). Also, a small set of income tax deductions and credits would be eliminated for taxpayers with incomes in excess of $100,000. Finally, the Administration is proposing a severance tax on oil, natural gas, and other hydrocarbons extracted from shale wells at tax rates from 4.5% to 6.5%.

Of interest to tobacco securitization bond holders is the Administration proposal to raise the cigarette tax rate by $1.00 per pack to $2.25 per pack. Research shows that increasing cigarette tax rates can accomplish the twin goals of raising revenue and reducing cigarette consumption. The reform proposal also increases the tax rate on the wholesale value of OTP (such as cigars, snuff, etc.) from 17% to 60%, to equalize the OTP tax rate with the estimated average cigarette tax burden as a percent of price. Finally, the proposal would introduce a new “vapor products tax” on so-called e-cigarettes, also at 60% of value. These changes are estimated to increase revenues by $528 million in FY 2016 and $463 million in FY 2017.


December’s rains enabled Californians to finally meet Gov. Jerry Brown’s call for a 20 percent reduction in monthly water consumption, but more restrictions loom as the state adapts to a drought. A survey released Tuesday that showed an unusually rainy month helped residents cut water use by 22 percent statewide from December 2013 levels. This welcome news was offset by the fact that the Sierra Nevada snowpack, which supplies a third of California’s water, is 75 percent below its historical average. Regular readers will recall a photo we published of San Francisco’s Hetch Hetchy Reservoir and its lower water levels. For the first time in recorded history, there was no measurable rainfall in downtown San Francisco in January, when winter rains usually come. The governor called on Californians to use 20 percent less water last year when he declared a drought emergency. The closest they previously came to reaching that goal was in August, when water use dropped 11.6 percent. The state has authorized cities to fine people $500 a day for violating restrictions on lawn watering and washing cars.

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