Spring 2018 issue of Horizons

issuance, are unlikely to provide the interest savings historically experienced with advance refundings. For example, Washington state recently refunded $500 million of general obligation bonds in November 2017, with a reduction of debt service cost of approximately $70 million, which amounts to a 9.79% present value savings versus the old bonds, per the Office of the Washington State Treasurer. This project would not have been possible in its current form under the Act, as certain bonds refunded had call provisions limiting the redemption of those bonds to future dates, making the state wait until those dates to perform a current refunding of the bonds. If the state had to wait to perform the refunding project, it is possible that interest rates would not have been as favorable in the future, considering projections foresee interest rates to rise significantly over the coming years. As of January 1, 2018, all state and local governments now must wait until they have met call provisions on their bonds (on average ten years from the issuance of the original bond) before they can perform similar refunding projects, missing out on potentially favorable changes to interest rates. The rationale for removing the tax-exempt status of advance refund bonds was to result in interest earned on future refunding projects to be taxable on the federal level. This change is expected to raise revenue by $17.3 billion over ten years, based on a report by the Joint Committee on Taxation. This assessment assumes that governments will still refund at the current rate in 2018 as they have been historically. However, there is some concern that governments will forgo refunding projects completely instead of using higher interest rate, taxable-refunding bonds. Additionally, the move likely frees up the bond market from refunding projects. Various reports estimate that approximately 23% of the supply of the overall tax-exempt bond market was consumed by advance

refunding projects. This move will allow more issuances to be focused on original capital projects and reduce the number of debt issuances for single projects. Fortunately, for local governments, public activity bonds were maintained under the Act. Initial discussions and revisions of the bill were prepared to repeal these activities, but it was determined that these instruments were necessary to finance certain projects including airports, water and sewage facilities and other significant projects. The removal of activity bonds would be onerous to local communities trying to find funding for significant projects. Limitation of Deduction of State and Local Taxes Another significant change that will affect local governments beginning in 2018 is the limitation of federal deduction of state and local taxes on individual returns. Individual taxpayers are now allowed to deduct up to $10,000 of all state and local taxes, including property, sales and income taxes, from adjusted gross income to arrive at their taxable income. This deduction for 2017 was unlimited, which greatly increased an individual’s tolerance for increasing – and subsequently paying state and local tax and avoided penalizing the individual for funding state and local initiatives. The future impact of this change, if it remains in its current form, would be on governments who derive significant portions of their income from property or sales taxes.

the Act will have a substantial impact on state and local governmental entities and their ability to finance operations

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