Corporate Tax

The Construct Again Higher laws supplies for a 15% corporate tax that might be levied on tax-exempt municipal bond revenue

Not only did the Build Back Better legislation unveiled yesterday by the White House failed to address the priorities of the municipal market, it could also hurt demand for municipal bonds from institutional investors.

The bill introduces a new minimum corporate income tax of 15% that would apply to adjusted financial statements for companies with annual incomes greater than $ 1 billion. By including income from financial reporting, the provision would likely include tax-free income.

“This tax, if it appears to be imposed, would directly affect banks and real estate and casualty insurance companies as buyers of tax-exempt bonds and constitute a tax on otherwise tax-exempt interest,” a statement from Bond Dealers of America said. “The provision would dampen corporate demand for tax-exempt bonds and likely lead to higher funding costs for state and local governments. Hopefully Congress will reconsider this hasty proposal before the legislation is finalized. “

The new tax is estimated at $ 325 billion, according to the Build Back Better framework.

The provision is part of the $ 1.75 trillion budget balancing bill released Thursday by the White House and the House Ways and Means Committee. The bill was cut in half from the original $ 3.5 trillion house package, which included a number of muni-friendly priorities like restoring tax-free prepayments and a new direct bond payment program. The minimum corporate tax of 15% is added to these losses. Overall, the BBB framework represents “a significant blow,” BofA Global Research said in a statement on Friday.

The group of companies that would be affected by the new minimum tax together account for about 24% of Muni’s ownership, Morgan Stanley said in a statement released on Friday.

“The newly proposed corporate minimum tax, if it goes into effect, could put valuations under pressure,” the bank said. In the medium term, the tax could mean higher average risk premiums and “more frequent spurts of volatility”.

It is difficult to gauge the impact of the provision on pricing, but for example, the alternative minimum tax on bonds of private activities in the market is estimated at a penalty of 50 basis points, all else being equal, according to a 2018 congressional congressional research report to PABs.

“It is unfortunate that the municipal bond provisions have been removed from this version of the Reconciliation Act, and hopefully Congress will restore these important state and local government funding measures,” said Kenneth E. Bentsen, Jr., President and CEO of Securities Industry and Financial Markets Association “We also fear that the proposed change in the corporate minimum tax rate, as it is now being drafted, would negatively impact some investor demand for municipal bonds and increase costs for state and local issuers.”

House spokeswoman Nancy Pelosi had hoped to hold a vote on the bipartisan infrastructure bill this week, but the legislation can now begin next week along with the reconciliation bill.

Bloomberg news

It may be too early to calculate the demand impact of provision, said Tom Kozlik, head of municipal Research & Analytics at HilltopSecurities.

“The corporate tax rate is a factor in the relative purchase of value, but not necessarily a leading factor,” said Kozlik. “It’s not necessarily something that makes them rush out and sell or not buy.”

The Build Back Better framework also offers a new 5% surcharge for those with incomes greater than $ 10 million and an additional 3% for incomes over $ 25 million. These provisions would likely boost demand as wealthy investors seek tax breaks, Muni strategists said.

On the other hand, this surge in demand can be offset by lowering the federal deduction limit for state and local taxes. A revision of SALT is not now included in the Reconciliation Act, but several key lawmakers have announced that they will withhold their support unless it is included.

Barclays pointed out that a two-year suspension of the SALT cap that is in circulation could curb demand for tax exemptions, especially in high-tax countries like California and New York. “Overall, we expect a decline in retail demand from SALT, which will be offset by increased demand from private individuals in the higher tax brackets,” Barclays said in the report. “We expect retail demand to remain solid, even if it may decline a little.”

Nothing is over until the invoice is signed, sealed and delivered, market participants said.

Morgan Stanley noted that the executive would need to clarify tax rules after Congress passed the bill, which “could theoretically clarify that Muni interest will not count as minimum taxable income.”

In the meantime, a planned vote by the House of Representatives on an accompanying bipartisan infrastructure law fell apart on Thursday, forcing the House to approve another short-term extension of the land transport programs until December 3, in order to avoid the end of funding on October 31.

Legislators are reportedly due to return next week to resume negotiations on both bills.

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