The fiscal cliff agreement reached at the end of 2012 – and passed by Congress on January 1, 2013 – has done little to reassure tax-exempt health care organizations that the tax-exempt bond market will remain unaffected by comprehensive tax reform in the future. Both borrowers and lenders should prepare to encounter programs and proposals to alter the federal government’s tax policy and reduce the value of the number of income exclusions, exemptions, deductions and credits (collectively, “tax expenditures”) over the next few years.
A persistent topic of fiscal year reform discussions is the elimination or limitation of the exclusion from income of interest on bonds issued by governmental and tax-exempt entities. In recent weeks, both the Internal Revenue Service’s National Taxpayer Advocate and the United States Government Accountability Office (GAO) have continued to urge Congress to make tax reform its highest priority and to reassess the need for every tax expenditure, including the exclusion of tax-exempt municipal bond interest from income. The total tax expenditures related to exclusion of interest for state and local bonds has been estimated by the U.S. Treasury to equal $25.7 billion for fiscal 2013. The GAO further asks lawmakers to consider key questions when evaluating tax expenditures – for example:
- whether the benefits of the tax expenditure exceed its costs
- whether net benefits are in the form of efficiency gains for society as a whole
- whether there are alternatives to the tax expenditure that might more effectively achieve its purpose
The potential for eliminating or limiting the exclusion of tax-exempt municipal bond interest from income has important consequences for capital planning by tax-exempt health care organizations. If interest rates rise as a result, there are unanswered questions regarding how much capacity the market will create for non-exempt debt of health care issuers. Uncertainty surrounding the organizations’ ability to obtain financial resources is particularly concerning as provider organizations seek revenue streams to finance health reform initiatives and increase their stability for the future.
Another key issue in this discussion is whether any change in tax policy would apply prospectively only, or would also affect existing debt. President Obama first proposed a 28 percent cap on all tax expenditures, including the exclusion from income for municipal bond interest, in a jobs bill, then proposed it again in his fiscal year 2013 budget request. He is expected to propose the cap again in his fiscal year 2014 budget request, which is anticipated to be issued in March or April. The Municipal Bonds for America coalition has warned that a retroactively applied 28 percent cap on the value of tax exemption would amount to an unprecedented retroactive tax that would raise borrowing costs for issuers, limit infrastructure development and constrain economic development, potentially lead to huge investment losses for municipal bond-holders, and make investors wary of tax-exempt bonds. The coalition has highlighted how, as indicated by the municipal bonds market in December 2012, the threat of a cap only prompts investors to demand higher yields to adjust for the cap. Furthermore, any retroactive effects may trigger “make whole” provisions in existing debt obligations (i.e., require borrowers to pay bondholders additional amounts to offset their tax liability), and/or create covenant defaults under existing obligations. While the President has assured investors that the cap is not meant to target municipal bonds, and administration officials hope for tax reform without the need for such a cap, the potential cap continues to be on the table in budget and tax reform discussions.
Tax-exempt health care organizations are advised to take a longer-term view when considering capital expenditures and remain cautious about downside possibilities over the next few years. With the implementation of the Affordable Care Act (health reform law), health care organizations need to ensure adequate infrastructure to accommodate the millions of Americans who will have access to health insurance coverage beginning in 2014. The terms of any new borrowing must be reviewed carefully in light of the looming possibility of adverse changes in federal tax policy.
In addition, tax-exempt health care organizations may consider elevating their advocacy efforts and engaging with members of Congress, particularly as Congress contemplates a comprehensive tax overhaul for the first time since 1986. In February 2013, the U.S. House Ways and Means Committee formed 11 bipartisan working groups of members of Congress that serve on that committee to work toward outlining the components of a tax reform legislative package. The relevant working group for tax exempt health organizations is labeled “Charitable/Exempt Organizations” and is being led by Representatives David Reichert (R-WA) and John Lewis (D-GA). Each working group is developing recommendations, which will be reported to the Ways and Means Committee by April 15, 2013. At that point, a public comment period will open for response to the proposals until May 6, 2013.