Tax Cut To Hurt Local Government

June 13, 2003
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GRAND RAPIDS — The Tax Policy Center reported that married couples and high-income earners will benefit the most from the new tax cut.

Those with an annual taxable income of $100,000 and above will receive 56 percent of the $350 billion cut. A millionaire will get a tax cut worth $88,236, on average, according to the center.

Marrieds will have their standard deductions raised from $7,950 to $9,500, more than twice the standard deduction for singles. And most marrieds with children will get an extra $400 for each child they have under the age of 18.

But the tax cut, which includes slices from dividends and long-term capital gains, isn’t as generous for municipalities. Cuts to dividends and capital-gains-from-sales will result in more costly building projects for the city and Kent County.

Why? Because the interest rate that governmental units will pay on tax-exempt bonds will be higher.

Kent County Fiscal Services Director Robert White said government debt typically trades from 70 percent to 80 percent of 10-year Treasury bills, which, unlike tax-exempt bonds, do carry a taxable interest rate. But when other instruments take investors near that tax-exempt status, it broadens the amount of product that offers that status.

“When there is more supply, and not as much demand, interest rates have to go up to generate more demand,” said White. “So the spread between tax exempts and Treasuries will narrow. In essence, government will have to pay a little more for the money it borrows.”

Of course, having to pay more for every dollar it may borrow for the immediate future means it becomes even more important for the county to maintain its Triple-A bond rating. That top-of-the-line rating helped to quickly sell $84 million worth of zero-coupon bonds and current-interest securities over just five days in December of 2001 for construction of the $212 million convention center. The county backed the bonds.

That rating also kept the interest rates lower than they would have been had the county not been rated Triple-A. Yields for the current-interest securities ranged from 1.93 percent last year to 4.69 percent in 2014. The longer-term capital appreciation bonds ranged from 5.15 percent in 2015 to 5.59 percent in 2031. The average interest rate for the zero-coupon bonds was 5.25 percent for the 30-year issue.

How much more municipalities will have to pay to lure investors to building bonds is anyone’s guess now. White felt the amount would depend on how public companies declare dividends, if they pay dividends instead of doing splits, among other issues.

“It depends on how equity companies try to pass money back to stockholders,” he said, while adding that he would likely have a better handle on it next year.

White did say higher rates would have meant a lower principal for the DeVos Place bond issue. It would have been smaller than $84 million, along with $2 million in premiums, which it contained.

Right now, though, those lower rates are gone at least until 2008, when the sun sets on the dividend and capital gains cuts — unless Congress votes to extend both. But, as with most things in life and business, there is a bright side to the issue — it could have been worse.

“President Bush actually asked for much bigger exemptions on dividends and capital gains than what he finally got. So there was some compromise there. They didn’t give him everything he wanted,” said White.

“But to the extent that they keep expanding the investment instruments under which someone can enjoy tax-exempt status, then that dilutes the market,” he added, “which means that all interest rates on the tax-exempt market will be a little bit higher.”           

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