The Reagan administration's massive income tax cuts have undermined drastically the market for state and local bonds, further disrupting local government borrowing patterns already skewed by high interest rates, a finance expert reported yesterday.
By reducing taxes on high salaries and offering other forms of tax-exempt investment such as the All Savers certificate, the tax bill has driven away a substantial segment of the traditional market for tax-exempt local government securities, said John E. Peterson, director of the Government Finance Research Center of the Municipal Finance Officers Association.
"The new program may be a shot in the arm for the private economy, but so far it appears to have zeroed in on other anatomical targets when it comes to state and local finances," said Peterson. His report, published in the group's "Resources in Review," said that "the longer-term prognosis is not good" for an improvement in the "gloomy performance of the municipal bond market."
Petersen's assessment, which is shared by many state, city and county finance directors, is that the combination of high interest rates and disincentives to purchase municipal bonds is undermining the traditional structure of local government credit. Local governments will either be saddled with staggering costs for interim borrowing or will have to defer needed capital projects, with a corresponding loss of jobs and public services.
Reduction of the market for the bonds that have been local governments' traditional source of long-term credit is only the latest in a series of economic blows that federal policy has dropped recently on states and cities. Reductions in the federal budget have cut their direct grant aid, just as federal income tax cuts have reduced the states' revenue because their tax formulas are often linked to those of the federal government.
The District of Columbia does not issue bonds, though it is seeking congressional authorization to do so. But officials in the Maryland and Viriginia suburbs have said recently that their long-term borrowing plans are in jeopardy. Even if buyers can be found for their securities, they said, they are unwilling to commit themselves to long-term debt at rates now exceeding 13 percent.
The alternatives are to defer borrowing, which means deferring needed construction and maintenance, or to borrow short-term at high commercial rates and refinance those debts from bond revenues when bond sales once again become feasible. Arlington County, for example, is contemplating the issuance of short-term, high-interest "bond anticipation notes" this fall.
"That's a gamble," Petersen said at a briefing for reporters. "If you shift into the short-term market, which many local governments are doing, you incur high costs and reduce your liquidity, gambling that you will be able to roll over that debt."
State and local bonds generally pay less interest than other forms of investment, but they are exempt from federal taxes and thus traditionally have been attractive to high-income individuals seeking tax shelters. According to Petersen, there is a "lesser need for tax shelters and too many other people who can provide them" as a result of the new income tax law.
The law created the so-called All Savers certificate, which allows individuals to earn up to $1,000 and married couples $2,000 in interest tax-free on certain savings deposits. It also reduced the top tax rate from 70 percent to 50 percent, lessening the demand for tax-sheltered investment.
"The reduction in the capital gains rate, the drastic lowering of the estate taxes, expansion of retirement savings plans and lowering of individual income tax rates have lessened the need for tax shelter and made it more readily available."
The cumulative effect, he said, is to further erode a market already weakened by the reluctance of large-scale buyers such as insurance companies and banks to commit themselves to 15- or 20-year investments at fixed-income rates.