Wonder Woman isn’t the only Amazon who’s beating people up. Municipalities across the country are competing to land the second headquarters of the giant online retailer of the same name, including an offer by Chicago to give tax revenue collected from Amazon workers directly to Amazon. But Chicagoans wouldn’t be the only ones to lose out if that city wins the business. Unless Congress cuts back on an egregious Internal Revenue Code tax break, federal taxpayers across the country will subsidize the competition. Triple-tax-exempt debt encourages municipalities to gorge on low-rate debt that may be difficult to pay back later. It disproportionately benefits the rich, while offloading much of the interest expense onto the federal government.
The federal government exempts most debt issued by states and their subdivisions, such as cities, counties and public authorities, from federal income tax. States and localities exempt this debt from their own income taxes, which is why it is referred to as triple-tax exempt debt. (For consistent terminology, let’s refer to all issuers, including states, as municipalities, and the debt as municipal debt.) Because investors are only concerned with their after-tax return, municipal bonds can be issued at an interest rate lower than that for taxable bonds. As a simplified example, if the interest rate on a taxable bond would be 5 percent, an investor with a 40 percent combined federal and state marginal income tax rate would be willing to accept a triple-tax-free bond providing the equivalent rate after taxes — in this case, 3 percent.
The House and Senate bills are currently split on the tax break for a subset of triple-tax-exempt debt: private activity debt, which is issued for non-government purposes but still exempt from federal, state, and local income tax. In the most recent publicly disclosed iteration, the House would eliminate the private activity debt exemption, while the Senate would keep it. The Treasury assigns an $119 billion total cost to private activity bond tax expenditures from 2018-27.
In theory, the tax break for private activity debt reduces financing costs for private entities whose activities are deemed to be for the benefit of the public, such as airports, water facilities, and nonprofit hospitals and higher education institutions. In reality, private activity debt often funds rent-seeking economic development schemes, such as sports stadiums, which numerous studies have shown provide no economic boost beyond the owners and athletes themselves. Below-market debt has also fueled massive capital spending by hospitals and nonprofit universities, whose debt service costs get passed on in the form of higher health-care and tuition prices, without necessarily improving outcomes.
Tax expenditures for private activity debt are only a fraction of the size of those for state public-purpose debt, which neither the House nor Senate proposals address. Triple-tax-exempt status for public purpose debt is supposed to subsidize core state government functions. Instead, like the special effects in a Wonder Woman movie, it often funds fiscal illusion: politicians persuade taxpayers that debt-funded spending is cheaper than raising taxes. But the debt still comes due at the end of the day, as demonstrated by the insolvency of Puerto Rico, whose debt has triple tax exempt status for taxpayers in all states. The Treasury estimates public purpose debt tax expenditures at $360 billion over 10 years.
Cheap public purpose debt encourages vanity projects, often at the expense of maintenance of existing infrastructure, such as California’s pursuit of a $64 billion high-speed rail boondoggle while its Oroville Dam deteriorated almost to the point of failure. In New York City, public authorities deferred maintenance and let mass transit decay to levels last seen in the 1970s fiscal crisis. Instead, they funded huge new projects designed to raise the presidential profiles of regional politicians. These projects, plagued by cost overruns, include the Calatrava World Trade Center PATH terminal ($4 billion), the subway’s Fulton Transit Center ($1.4 billion), 7 train extension ($2.4 billion) and Second Avenue line ($4.5 billion), and the Long Island Railroad’s East Side Access ($10 billion). A recent study by Liu, Moldogaziev and Mikesell found that states with more public corruption had more per capita debt, although correlation is not causation. In the Jefferson County, Alabama, sewer system reconstruction, massive corruption resulted in a Chapter 9 municipal bankruptcy.
Virtually every municipality competing for Amazon’s second headquarters will be funding part of its package with private activity debt (which will be directly for Amazon’s benefit) and public purpose debt (for infrastructure improvements whose primary beneficiary will be Amazon). In other words, even though the federal government doesn’t care where Amazon locates, federal tax expenditures will subsidize rent-seeking by Amazon, municipalities and their officials. These tax expenditures will be lavished despite a $26 billion overseas cash hoard on which Amazon avoids federal income tax, according to Bloomberg.
Even If, as Madison put it in Federalist 51, “angels were to govern men” and triple-tax-exempt debt funded only well-managed projects supporting core government functions, it would still be inefficient. Studies suggest that only about 80 percent of the tax expenditures reduce state borrowing costs; the rest predominantly goes to high-income households.
Given the looming municipal budget crunch from underfunded pension obligations, federal tax legislation should encourage the reduction of municipal debt rather than subsidize more of it. Under current low interest rate conditions, ending triple tax exempt status would be unlikely to cause a spike in rates. For example, the current yield on Vanguard’s New York Long-Term Tax-Exempt Fund Admiral Shares is just 2.24 percent. Any rate increase would be moderated by the entry of new investors. As the Tax Foundation’s Scott Greenberg observes, institutional investors who do not pay taxes, such as pension funds, have no appetite for the lower coupon rates of municipal bonds. If bonds were issued at market rates, those yield-hungry investors would enter the municipal bond market, bidding down interest rates. Institutional investors would also have an incentive to monitor issuers’ financial performance, reducing the risk of a municipal debt meltdown.
The additional revenue from ending the federal tax expenditure for triple tax exempt debt would modestly offset some revenue loss from the proposed tax bills. Congress can more efficiently fund infrastructure or other desirable investments through direct grants to municipalities, rather than allowing wealthy triple tax exempt debt investors to siphon off part of the tax expenditure. If Congress is truly besotted by Amazon, it could even make a direct grant to pay for the retailer’s second headquarters, which would expose economic development rent-seeking to the light of day.
