A Jobs Bill That Boggles The Mind

The Wall Street Journal  September 21, 2011

A Jobs Bill That Boggles the Mind

The president worries about the fiscal misfortunes of local governments, then proposes a plan to penalize municipal bond buyers.

By HARVEY GOLUB

When President Obama first started talking about a “jobs bill,” my initial reaction was one of amazement. He apparently has not learned from the failure of his first trillion-dollar stimulus package that no amount of government spending will achieve self-sustaining economic growth in light of his administration’s antigrowth policies.

And what exactly are those polices? First and foremost, the president has promised to raise tax rates on the “millionaires” making more than $250,000  per household. Meanwhile, he’s ignored entitlement reform, retarded the development of our energy resources, and added new layers to our regulatory burden. He’s also increased the uncertainty inherent in an already dysfunctional and perverse tax code, added trillions to our national debt, spent taxpayer money ineffectively and inefficiently, tried to micromanage the economy, and acted as an incompetent venture capitalist by investing in “green jobs” and high-speed rail.

This administration routinely grants and withholds favors by substituting its judgment of what is valuable and good for that of the people. What stimulus spending can do to create jobs is entirely temporary, whether in the public or private sector, and is rooted only in a political calculus.

When I read the president’s jobs program, my concern deepened as I realized that his whole approach is a metaphor for the broader Obama economic plan. For example, on the one hand he wants to devote almost half the $4 75 billion in additional federal spending to states, as he says, to employ teachers, policemen and firefighters and refurbish or build some new infrastructure that states have already decided they don’t need or have deemed a low priority.

On the other hand, the bill will add billions of dollars per year to state and local government expenditures by reducing the tax benefit of state and municipal bond issues for taxpayers earning more than $250,000  per year. In total these bonds represent $25  trillion in outstanding bonds, with billions more issued each year.

The president obviously believes that tax-free bonds are a benefit to the buyers when, in reality, the benefit accrues entirely to the municipalities that issue the bonds. Because the bonds are tax-free, the issuers pay a lower interest rate-by an amount almost exactly equal to the tax benefit. By reducing the benefit, municipalities will be forced to pay significantly higher rates, increasing their annual debt-service cost. And, since high earners comprise only about one third of the owners of these bonds, lower-rate taxpayers will receive an added benefit from the higher interest paid. In effect, the municipalities will pay more in interest than the federal government will receive in tax payments.

Investors in new bond issues will be unaffected. Those investors that have portfolios of municipal bonds will switch to high-grade corporates or pay the tax from the higher interest payments they’ll receive. All of the supposed increase in tax payments from this plan will simply be a transfer from municipal and state governments to the federal government through the hands of investors.

The president also wants these reduced tax benefits to apply to existing bonds, bought under the assumption of receiving the higher tax benefits. It is not very often that higher taxes are applied retroactively, but this will be one of those times. As a result, existing bondholders will see the value of their municipal bonds decline substantially based on the lower tax benefits.

The interesting questions for me are: Did anyone on his economic staff, at Treasury, or at the Office of Management and Budget tell him about this? Did he even ask?

From my perspective, interest on municipal debt should have no tax-free benefits at all. Municipalities should pay market rates based on their credit-worthiness and individuals should pay taxes on the interest just as they do when they buy corporate bonds. The current system, in effect, subsidizes heavy issuers of bonds at the expense of states that issue bonds at more modest levels. If the true cost of borrowing were reflected in the interest rates, these local and state entities may moderate their spending levels. But if the president wants to count this as a tax savings, let’s make the change in the context of a far broader reform of the tax code and do so prospectively.

From green jobs to “cash for clunkers,” many of us have suspected that economic illiterates were setting the economic policy of this administration. The president’s jobs plan proves the point. That the president could wail about the misfortunes of municipalities and argue that the federal government urgently needs to send cash, and then simultaneously propose a change in the tax treatment of municipal bonds that takes the cash back, reveals a depth of cluelessness that boggles the mind.

Mr. Golub, a former chairman and CEO of American Express, is the chairman of Miller Buck.fire and serves on the executive committee of the American Enterprise Institute.