Impact of federal tax overhaul will emerge over time

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From the Beacon, January 2018
 
As you know, the MMA joined with dozens of nonpartisan municipal, state and national associations to express grave concerns regarding the new federal tax law, and we opposed many of the proposed changes during the process.
 
Thankfully, a number of the problem sections in earlier drafts were removed during negotiations on the final tax legislation. There are, however, many structural aspects that will have negative impacts on cities and towns. The full scale of this will take years to determine, in part because of the as-yet-unknown impact on the state and local tax base, unquantified changes in the municipal bond market, and future cuts to important domestic programs.
 
First, we want to thank the members of the Massachusetts congressional delegation for their success in eliminating several proposals that would have immediately harmed cities and towns. The original legislation would have eliminated tax-exempt private activity bonds, which are used to leverage private investment in vital housing and economic development projects. This would have made these municipal initiatives much more expensive and reduced the scale of affordable housing and revitalization efforts at the local level. In the end, private activity bonds were protected.
 
Similarly, the original bill would have eliminated the historic tax credit, which is used to restore essential community assets and inject new vigor into neighborhoods. Just think of the number of old mill buildings in Massachusetts that have been converted into attractive housing that anchors economic investment. Virtually all of those projects – and thousands more – would have been more expensive for taxpayers and residents without the historic tax credit. In the end, the credit was salvaged, and faced only minor changes.
 
While these two tax policies were protected, several other negative changes remained, in spite of the best efforts of our congressional delegation.
 
Until now, the federal income tax has always provided for the full deductibility of state and local taxes. The federal tax code has done this so that average taxpayers are protected from double taxation. But the law enacted by Congress and the president ignores this basic promise to taxpayers, and the result will be bad for our state and for our communities. The end result is that Massachusetts households will only be able to deduct the first $10,000 in state and local taxes.
 
Capping the state and local tax deduction will make it harder for taxpayers and communities to adequately fund essential services. Further, the new law will make it much harder for cities and towns that need to pass a temporary property tax increase to pay for rebuilding their public schools, or a new fire truck or police station. Why? Because Massachusetts taxpayers will pay twice – once for the new or renovated school and a second time to the federal government. And those new federal taxes won’t come back to Massachusetts, they’ll be used to reduce the corporate tax rate. That’s a troublesome shift – away from public schools and into corporations.
 
The state income tax pays for health care, public colleges, addressing the opioid crisis, and other important social programs to support families. Capping the state and local tax deduction will make it harder for taxpayers and state leaders to adequately fund these essential services. It will take several years to measure the exact impact, but it is very likely the result will be smaller revenue increases over time.
 
Municipal finance experts are predicting that cities, towns and states may also face higher debt costs, due to the tax reform. (Governing magazine has an interesting article on this topic.) This is because the reduced corporate tax rate may trigger clauses in many loan agreements that allow lenders to increase interest costs if their corporate tax rate is cut. (These bank-friendly, backward-looking provisions are intended to protect banks from a loss of revenue under the theory that they would have demanded higher interest rates because they would have had less need to shelter income from federal taxes.) Communities should check the language in their bank agreements to see if these legacy provisions exist.
 
This leads to the greater long-range trend. Banks and other investors will now see their federal tax rate decline significantly. This means that municipal (tax-exempt) bonds will be of less value, since these investors will need to shelter less income from taxation. In response, issuers (cities and towns) will need to offer higher interest payments to make the bonds more attractive. This will take several years to evaluate definitively, yet it is highly probable that communities will pay higher borrowing costs, which will make important capital projects more expensive for taxpayers, or force cities and towns to reduce the scope of their infrastructure investments.
 
Finally, the tax package will create a huge $1.5 trillion hole in the federal deficit over the next decade. And we expect that this will lead to cuts in important programs, such as health care and hospital reimbursements, Community Development Block Grants, federal education programs for needy students, brownfields reclamation, transportation, and public health and defense research grants. Each one of these is essential to economic growth here in Massachusetts.
 
The new tax law makes it hard to imagine how the president’s promise of a new $1 trillion infrastructure program to rebuild our roads, bridges, waterworks and airports can be fulfilled. Indeed, the administration is now saying that its infrastructure plans are predicated on new, increased funding by municipal and state governments – even though this will be much harder to accomplish because of tax reform, and is the opposite of what was indicated last year.
 
The scope of federal budget cuts will materialize over time, yet it is safe to say the impact will be greater because of the $1.5 trillion burden that has been added to the national debt.
 
The bottom line is that federal tax reform could have presented more immediate pain for local governments. But the final framework will create long-term financial challenges for cities and towns. Our worry is that in the long-term the new law will weaken state and local finances. If that materializes, communities will have greater difficulty delivering quality education, public safety and family-based services to the citizens of our state.
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