Since the D.C. Council voted on the fiscal 2012 budget last week, I’ve heard from several readers upset about the proposed tax on non-District municipal bond proceeds.
A quick recap: The District is now the only place in the country that does not charge local income taxes on municipal bonds issues outside its borders. Each state has exempted its own public bonds from state taxation, but the District has extended that treatment to all states — in part, because it historically issued no debt and simply borrowed from the federal treasury.
The readers have raised several arguments in support of maintaining the exemption: that it is unfair to bondholders who made non-D.C. munis part of their portfolios expecting them to remain tax-free; that it will disproportionately affect seniors, who hold munis in their retirement packages; and, most of all, that the District, unlike the 50 states, doesn’t issue enough different types of bonds to justify ending the exemption.
One person wrote that D.C. bonds are “very few in number and not usually particularly attractive” and that an investor would “not be able to obtain adequate diversification” by purchasing only District issues.” Another reader said that a bond tax it would “reduce [residents’] future investment choices, and allow them more limited choices than are available in all other states.” Another wrote that the “risk of such concentration would be excessive,” noting the following: “California has the worst state bond rating and the largest economy; D.C. has the opposite. But a retail investor would prefer a sufficiently diversified portfolio of California bonds to a single D.C. general obligation bond, everything else being equal. Why? Because overall it would be less risky.”
David Umansky, spokesman for the Office of the Chief Financial Officer, which issues all city debt, was happy to address those claims in some detail — starting with the notion that the city, less than a decade from federal control, is a risky investment.
”Obviously, the District is in a much better financial position than when the Control Board was here, as indicated by the current bond ratings versus the ratings at that time,” he writes. “Plus, the District has never defaulted on any of its bond payments, even during the Control Board era.” (I would add that Control-era reforms have made default exceedingly unlikely.)
As for a lack of diversity, Umansky writes: “Our Income Tax Secured Revenue Bonds have become our primary type of bond issuance, and we now have $2.9 billion of them outstanding. These bonds are rated AAA, Aa1 and AA+ by Standard Poor’s, Moody’s and Fitch, respectively, very high quality ratings. Our General Obligation Bonds (payable primarily from Real Property taxes), of which we also have $2.9 billion outstanding, are rated A+, Aa2 and AA-, respectively, by these same rating agencies. So between these two types of bonds, there is diversity in credit rating and in repayment source. In addition, there are other District revenue bonds available in the marketplace, such as Ballpark Revenue Bonds, Convention Center Revenue Bonds, DC Water Sewer Authority Revenue Bonds, Metropolitan Washington Airports Authority [Revenue Bonds,] DC Housing Finance Agency Revenue Bonds, and tax-exempt municipal bonds issued by the District’s Industrial Revenue Bond program on behalf of independent institutions, such as local universities and hospitals. These bonds have varying credit qualities and repayment sources, providing numerous opportunities for diversity.”
Umansky also notes that D.C. residents have not had much incentive to purchase the city’s own bonds, given that it was likely more convenient to purchase other states’ offerings. One of the readers pointed out to me that, unlike the 50 states, there is no mutual fund of tax-free District bonds. Umansky notes that the tax proposal would increase the demand for D.C. bonds among D.C. residents — and, one would imagine, create an incentive for an investment house to assemble a D.C. bond fund.
And Umansky offers one other thought: “If D.C. munis are so unattractive,” he writes, “why do they draw such low interest rates and are generally oversubscribed?”