As 2012 draws to a close, both sides of the aisle in Washington are grappling with how to reduce the $16 trillion national debt and avoid going over the "fiscal cliff." As is often the case when taxes are under discussion, the conversation quickly turns to how to get the most revenue for the federal government while impacting the fewest individuals and businesses.
To that end, one of the ideas that has been floated is the elimination of tax exemptions for municipal bonds. Municipal bonds are used by public entities, such as cities and utilities, to finance much-needed infrastructure in our communities. Advocates on both sides of the aisle argue that removing or limiting the tax exemption would increase the interest paid to the federal government and help reduce the federal deficit. This argument has serious flaws and will have a significant financial impact on all taxpayers and ratepayers.
On the surface, it seems that the typical American would feel no pain if municipal bond tax exemptions went away. But a deeper look quickly shows that if the exemptions end, every American would in fact pay more, far more, for essential services like electricity and water that are provided locally.
For more than a century, municipalities like the Sacramento Municipal Utility District have issued municipal bonds to finance long-term infrastructure projects that directly benefit our community. Each year, SMUD issues up to $150 million in municipal bonds with an average term of 20 to 25 years. These bonds are extremely cost effective and finance projects that help keep the lights on and electricity affordable.
Should the tax exemption disappear, SMUD, along with cities, counties and the state, would have to borrow money at higher interest rates. Each year, SMUD's interest bill could increase by $2.5 million. As the more costly debt eventually replaces existing tax-exempt funding, the annual interest cost increase would be $50 million to $70 million. This added cost could translate to a 4 percent to 6 percent increase in electric rates for all our customers. SMUD is proud of the fact that ours are among the lowest rates in California (our rates are approximately 22 percent lower than neighboring utilities) and currently has no plans to raise rates next year. Should tax-exempt financing be eliminated, this could change.
SMUD is not alone. Every state, city, county, water district, etc. uses tax-exempt municipal bonds as a financing mechanism. The economic impact would be tremendous and the pain felt in households all across America.
Who will pay if the exemptions go away? You will. Your kids will. Your grandkids, too. To fund critical infrastructure projects, SMUD would be forced to raise rates over and over to cover the higher interest rates. Cities and counties would likely raise their taxes and cost of services. You will pay much more and receive, at the best, the same, because physical infrastructure is required to provide local services.
If a community couldn't bear the cost of raising rates and costs of services, needed projects would likely be deferred, further eroding our infrastructure. Broken things might stay broken longer, and new things might not get built. That's no recipe for a thriving society or economy.
For more than 100 years, tax exemptions on municipal bonds have benefited every aspect of our society. Washington would be well advised to listen and reach out to local community leaders and fully understand the ramifications of its actions. In full light, eliminating the tax exemptions for municipal bonds should forever be taken off the table. Communities can't afford it. We can't afford it. Municipalities can't risk it.