Tax Bill Municipal Impacts
One would think that the recall election taking place in California is the most important event in the state. The vote is certainly important, and most polling indicates the governor will prevail but there is always that bit of doubt that remains until the actual vote takes place.
I would venture to say that in terms of the budget outlook, the package of tax increases that have been released may have an even greater effect overall. Tax surcharges for those earning over $5 million, an increased top bracket, an increased capital gains tax with certain thresholds, an increased corporate tax, and a lowered basis for the death tax are bound to have more far-reaching implications.
Most state budgets rely on income taxes and capital gains taxes. California has always relied on capital gains taxes despite some fluctuations in good and bad years. The related revenues tend to be in the high single digit to low double digits as a percentage of general fund revenues. The change from a 20% capital gains tax to 25% at the federal level may not sound like a large change but it is bound to directly affect investor behavior. The first strategy would be to defer taking gains where possible that would lead to a lower tax take for state coffers. The exercising of options for the tech crowd may also slow.
Lowering the threshold for the “death” tax may be more of a motivator to relocate to a low or no tax state given the related effects in each state.
The move back to the 39.6% for the top bracket should not have an outsized effect since it was in place not too long ago before the 2017 tax reform. But the combined effect with the state income taxes amounts to meaningful burdens on individuals and corporations.
I certainly appreciate that adding all the proposed benefits requires significant revenue increases. Having said same, the $2 trillion or so of revenue proposals does not offset the $3.5 trillion of spending. There are some other technical aspects that are targeted to produce a balance, but the yield of those items is always a bit more questionable in the longer run.
Some Democrats have suggested that the $3.5 trillion is too high a number for the social infrastructure spending. What gets cut out of the package to reach a lower number is going to require a lot of value judgment.
This process is part of the reason I remain cautious about what municipal benefits we will retain in the package. Keeping the reinstating of advanced refunding is certainly being celebrated by all. There are still real significant savings to be had by Issuers even after all the taxable refunding that has been accomplished. The price tag for the reinstatement is not very great, but municipals are always prone to arguments about benefitting the “wealthy”.
The reinstatement of a BABs like program makes good sense. Attracting the different buyer base helps in the bigger picture. There is a nuance with the benefit going to the issuer and not the investor but that remains to be sorted out.
We know that any legislative package that passes on the social infrastructure side is beholden to the rule of 51. I remain concerned about the linkages with the infrastructure legislation. Having come so far on the latter means we should not squander the closest opportunity we have had to get something approved that will provide many benefits to all including generations to follow.
The municipal market will easily absorb any companion tax exempt issuance that may be required given the abundant positive flows to the mutual funds this year with modest impacts on spreads and levels.
John Hallacy
John Hallacy Consulting LLC
09/14/21
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