Picking winners and losers in the budget battle

Promised tax cuts, a deficit that’s out of control and billionaires looking to shrink the government are careening towards a head-on collision as muni leaders brace for more attacks on the tax exemption.  

“A lot of the strategists and pundits who petitioned Senators and Congressmen on our behalf for the municipal market have their hair on fire, worried that the exemption is going to go away,” said Eric Kazatsky, head of Municipal Strategy for Bloomberg Intelligence. 

“It’s not as easy as just saying with the stroke of the pen your exemption is gone. It doesn’t work like that.” 

The comments came during a panel discussion on Thursday produced by The Volcker Alliance and the Penn IUR Advisory Board.  

Concerns are running high in the muni community that a Congress obsessed with cost cutting could find their way to ending the tax-exempt status of municipal bonds. Other out- of-the-box solutions being proposed include eliminating personal income tax. 

“We heard buzz today, and it’s certainly uncorroborated that there are draft bills going around in the Florida White House talking about elimination of the federal tax and replacing it with a flat VAT or sales tax in the 17 to 19% range,” said Kazatsky.  

“That’s hugely impactful to the lower end of the economy as they would go from getting a couple of dollars back at the end of the year from Uncle Sam to having their cost of living raise by a significant amount.” 

Billionaires Vivek Ramaswamy and Elon Musk have teamed up to form the Department of Government Efficiency with lofty budget cutting goals by way of eliminating federal departments and programs that have not been reauthorized by Congress. 

“You have Scott Bessent, nominee for the Secretary of Treasury out there with his 3-3-3 plan talking about bringing the budget deficit down to 3% of gross domestic product” said former House Representative, Carolyn Bourdeaux. “Right now, it’s over 6% so it would cut that in half, which is a big lift.” 

“Then we have the Tax Cut and Jobs Act extenders. Folks who don’t want to care at all about the debt or the deficit, just a straight up extension without offsets is going to add $4 trillion to the national debt through fiscal year 2035.”   

The TCJA knocked out advance refunding of tax-exempt municipal bonds and put a $10,000 cap on the deduction for state and local taxes, a one-two punch to the muni market.  

According to many experts paying for extending the TCJA brings up a list of familiar victims that includes Planned Parenthood, the Corporation for Public Broadcasting, and Medicare/Medicaid payments to the states. 

College riots over the war in Gaza spurred Congressional hearings and resignations at Columbia, Harvard, and the University of Pennsylvania.   

Colleges and universities are now facing credit hits from dropping enrollments as their tax-exempt bond financing emerges as a target.   

“All of a sudden you had people in Congress, saying, ‘Wait a second, Harvard has $100 billion on endowment, and they could borrow tax-exempt. Why is that happening?'” said Kazatsky. “They got on the radar there, and we’re not sure they’re coming off anytime soon.”  

Big picture worries about recession have been replaced with concerns about inflation. 

“If you add three policies, lower taxes, higher tariffs, restrictions on immigration. These all have some upward lift on inflation,” said Torsten Slok, a partner and chief economist at Apollo. 

“If you already have a strong economy combined with inflation, not back at 2%, that means that the Fed is likely going to cut less, and therefore short interest rates will stay higher for longer.”

Higher rates have not had much effect on munis lately. 

“We had higher rates for the last two years and the muni market saw record issuance this year,” said Kazatsky. “That shows a huge level of insensitivity when it comes to borrowing in the market for municipal issuers. It eliminated a taxable municipal market, which went from about 13% of total issuance to about 2%.”