The Tax Cuts And Jobs Act: Collateral Damage

Experts are warning that the fine print in the new tax law may include some bad news for economic development initiatives and infrastructure projects.


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Experts are warning that the fine print in the new tax law may include some bad news for economic development initiatives and infrastructure projects.
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Collateral Damage

Experts are warning that the fine print in the new tax law may include some bad news for economic development initiatives and infrastructure projects.

The Tax Cuts And Jobs Act: Collateral Damage

We haven’t spent a lot time obsessing about what’s in the new federal tax law—the nimbly named Tax Cuts and Jobs Act (TCJA)—rammed through Congress last month a few minutes after Mitch McConnell and his pals finished writing it behind closed doors. If the legislators who reordered the revenue framework for a $17-trillion economy didn’t read the bill before they voted on it, why should we have to stay after school and do their homework for them?

Tax Cuts Jobs ActBesides, TCJA promises to be the gift that keeps on giving (congratulations on the new tax-exempt status for your multi-billion-dollar inheritance, Ivanka—is that an extra plate of cheeseburgers you’re ordering for daddy’s dinner?), or (if you live in a state with high state and local taxes) taking. Like everyone else in America, we’ll wait for an upcoming paycheck to find out if the reduction in our withholding tax covers the cost of an extra donut with our morning coffee. We’re also looking forward to that exquisite moment when our accountant gently consoles us about deductions we can no longer claim, while trying to suppress a smile about the S-Class Mercedes he just purchased with the proceeds from 2,000 extra billable hours.

But the midnight oil is burning in the offices of people who get paid to anticipate the financial impact of a new tax code on large public and private initiatives, an analysis made infinitely more difficult because the IRS still must produce thousands of regulations for how these adjustments actually will be defined and implemented by the federal government. This is the same IRS that has had its manpower and resources reduced by more than a third in recent years (okay, we’ll stipulate here that nobody ever feels sorry for the IRS).

That gurgling sound you’re hearing is coming from the stomachs of economic developers and planners of large infrastructure investments who have discerned some language in the fine print of the TCJA that they’re having trouble digesting, like that swordfish taco you scarfed a half-hour before bedtime last night.

According to a report in a newsletter from our friends at the Lehigh Valley Economic Development Corp. (LVEDC) in Pennsylvania, a “little-mentioned revision” in the $1.5-trillion tax plan approved by Congress has eliminated the tax-exempt status of economic development grants and “could have a nationwide impact on state and local economic development initiatives and programs.”

The LVEDC report says the tax bill takes away the federal tax exemption for state and local monetary or land awards intended to incentivize or entice development into a particular location. However, the report notes that this change doesn’t apply to existing awards or programs that are under a master development plan, which appears to exempt existing initiatives underway in Lehigh Valley, including Allentown’s Neighborhood Improvement Zone (NIZ), Bethlehem’s City Revitalization & Improvement Zone (CRIZ), or existing Tax Increment Financing (TIF) districts.

Lehigh Valley officials say their initial perusal of the TCJA language makes them cautiously optimistic that the revisions will not have a drastic effect on the Lehigh Valley economy or local incentive programs. However, they said the overall impact across the nation will be “to diminish the effect” of economic development grants and similar project-financing initiatives.

“These changes will apply to every state and local government across the country, so it’s a level playing field that doesn’t create state-based winners or losers,” said Don Cunningham, LVEDC President & CEO. “It will certainly diminish the effect of economic development awards across-the-board and will give a greater advantage to programs and districts already in place where benefits will remain tax free.”

Prior to the tax bill revisions, grants and incremental financing programs were treated as contribution to capital and were not taxable income. The new language will treat them as taxable income for the recipient, meaning revenue from an incentive zone that would previously have gone back to a developer to pay off building loans for a project may now be subject to federal taxes, unless they are part of an existing master development plan, according to the TCJA.

PA officials expressed confidence that state tax abatement programs like Local Economic Revitalization Tax Assistance (LERTA) and Keystone Opportunity Zones (KOZ) also will be exempt from federal taxes, adding that the revisions enacted by the TCJA are likely to have a greater effect on states or regions that rely extensively on cash and land incentives to entice development, the LVEDC report says.

Simply put, states that have had great success using ultra-generous incentives to lure big-ticket economic development projects (we won’t name any of them, but you know who you are) may now have to decide if they’re okay with sending a hefty slice of state or local tax dollars to the Feds after they seal the deal.

New IRS treasury regulations covering the TCJA are expected to define a “qualifying” master development plan. Lehigh Valley officials think the NIZ, a 128-acre zone that includes portions of downtown Allentown and the Riverfront district along the western side of the Lehigh River, will pass the test. All taxes generated in the NIZ, with the exception of school district and city taxes, can be used to pay debt service on any financed improvements within the NIZ, which has fueled the revitalization of downtown Allentown. The officials also think the CRIZ, which consists of 130 acres of parcels designated for economic development and job creation within the city of Bethlehem, will past muster with the new regulations. Like the NIZ, state and local taxes collected within the CRIZ will be used to repay debt service to stimulate economic development projects within the zone.

An expert at the Brookings Institute meanwhile is warning that the TCJA could have a negative impact on public investments in our nation’s crumbling infrastructure. According to a Dec. 26 post from Brookings’ Aaron Klein, the TCJA increases the cost to finance infrastructure for states and local governments.

“The impact may be large and immediate enough to swamp the short-term impact of any infrastructure package Congress can put together in the immediate future,” Klein declares.

States, local governments and other public infrastructure providers (including port authorities and transit agencies) own an estimated 90 percent of non-defense public infrastructure assets, which they fund and finance through a combination of taxes, borrowing, and user and beneficiary charges. According to Klein, the largest immediate impact on the cost of financing infrastructure will come from increasing the cost for states to borrow through municipal debt (state and local governments borrow by issuing municipal debt—also known as “munis”—that enjoy the special status of paying interest that is not subject to federal taxes; the muni debt market is estimated to be $3.8 trillion). Many large infrastructure projects involve issuing municipal debt to finance the costs.

Here’s Klein’s theory: a significant percentage of muni buyers are wealthy individuals, particularly retirees. When the top marginal tax rate is cut, the value of debt being tax-free falls, Klein says. This decline in value from cutting taxes for the top marginal rates will ripple through and make the bonds worth less, meaning that new tax-free municipal debt will have to pay higher interest rates to attract capital. Higher interest costs for infrastructure agencies means less money available to build, repair and upgrade infrastructure.

Klein also believes the muni-market will take a hit from the TCJA’s corporate rate cut and its reduction in the size of deductions that can be taken for state and local property taxes.

Large corporations, especially banks and insurance companies, own an estimated 30 percent of all municipal debt. Because Klein maintains that when the marginal tax rate falls, the value of being ‘tax-exempt’ also is diminished, he predicts that the TCJA’s large cuts in corporate taxes may result in a sharp decline in the demand for munis from businesses, particularly banks and insurance companies. He also predicts that the capping of the deductions of state and local taxes (known as SALT) will make it difficult for locations to raise property taxes to support infrastructure improvements. However, Klein concedes that the exception in the TCJA for real estate businesses (including the one owned by a prominent public official who refuses to release his tax returns)–allowing them to continue to claim SALT deductions—could mitigate some of the new tax law’s impact on infrastructure financing.

We’ll stipulate here that for every economist like Mr. Klein looking at the potential downside from the TCJA, you can find one who says it will be a boon for growth. It reminds us of President Harry Truman’s famous complaint about economists: they tell you one thing with certainty, and then they always say “on the other hand.” Truman’s solution: “I’m looking for a one-armed economist.”

Which for some reason reminds us of Dr. Richard Kimball, but we digress.

At this point, we can’t tell you whether, long-term, the TCJA will be a good thing or a bad thing, so we want to be even-handed about this (sorry, Harry). But, as professional wordsmiths, we will take a moment to deliver our definitive verdict on the less-than-impressive prose (crafted by a very stable genius who is really, like, smart and knows a lot of big words, the best words) that was displayed in the title of the Tax Cuts and Jobs Act. It’s sort of like calling the Patriot Act the Take Off Your Shoes and Your Belt and Empty Your Pockets Act.

Uh-oh, that one’s already taken. It’s the header on a letter we just got from the IRS.

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