Joseph Krist

Publisher

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TAX INCENTIVES

The extent of the effect varied based on the type of incentive being offered. Research and development tax credits were shown to have the largest negative effect, followed by investment tax credits and property tax abatements. Job training grants were shown to increase a state’s dependence on the federal government for additional funding, whereas job-creation credits were found to have no significant effect on the fiscal health of a state.

The role and value of tax incentives in the economic development process has long been a favorite topic. So we are intrigued by the findings of some North Carolina State University researchers who wanted to see if the granting of financial incentives to encourage the creation, expansion, or relocation of businesses within their borders. The study used data from 32 states (accounting for more than 90 percent of all incentives offered by state governments) for the years 1990 to 2015.

Spoiler alert: “After controlling for the governmental, political, economic, and demographic characteristics of a state, we find that incentives draw resources away from the state. Ultimately, the results show that financial incentives negatively affect the overall fiscal health of a state.” The results of the analysis show that financial incentives negatively impact the overall fiscal health of the states offering the incentives.

The question is why? Tax incentives, for example, limit the revenue available for a government to collect, while also requiring additional expenditures to meet the increased demand for public services that come with economic expansion.

The research also generated some findings about state financial health in general. One of the areas of interest was the relationship between tax policies and the state/federal relationship. “States that have a Democratic majority in their legislature are healthier than their Republic majority counterparts… Specifically, legislatures that have a Democratic majority have a lower dependence on the federal government by 3.5% and a 48.0% lower debt ratio.

DISCLOSURE

It was almost amusing to see that the Government Finance Officers Association (GFOA) is upset with the tone of the latest effort by the municipal analyst community to get municipal issuers to accept disclosure requirements. It has been nearly 45 years since the Tower Amendment was passed. This effectively was taken as a thumbs up for issuers to come to market with only the most minimal disclosure requirements. Since then, the need for better, faster, and more detailed disclosure has never been clearer. Just ask those investors burnt by Puerto Rico’s almost comical lack of disclosure and accountability.

It has become a rule of thumb that whenever a GFOA officer or representative appears before an analyst gathering and the subject of disclosure comes up, that the GFOA rep will make an impassioned case against disclosure. Disclosure apparently prevents children from receiving a good education, citizens from receiving proper public safety protection, and will cause grass to grow in the cracks of the unrepaired pavement of city streets. Yes disclosure costs money but there are alternatives for borrowers who can’t or will not disclose. Finance your needs through bank loans. Some of your compatriots do it and they do not apparently have to disclose the existence of what is potentially a parity obligation with that securing holders of an entity’s public debt.

I do not know of another public debt market which permits different classes of borrower to meet widely divergent standards of disclosure. Yes we have many small borrowers in the municipal market and yes compliance and disclosure is a cost but that is true for many small corporate borrowers as well. That is why there is a significant bank lending role in the corporate market. And that is where small corporate borrowers finance their capital needs.

So now the small municipal borrowers are offended. Well, the refusal to act like serious professional entities could be construed as offensive, a tone which lenders might have trouble with. And perhaps the borrower/issuer community could give this some thought. The analysts have rightly called for more and better disclosure. Would the small issuer community rather be shut out of the market altogether? Would it prefer to have a narrower market for its needs rather than a larger, more diverse, and probably cheaper source of financing?

And here is where we get to take some blame. No matter how much we complain, cajole, or beg the buy side always caves in. The pressure to keep fully invested seems to have always outweighed the logic of having the best information possible to support our investment decisions. The litany of municipal defaults which occurred against a backdrop of insufficient disclosure is well known – Cleveland, WPPSS, Detroit, and Puerto Rico. And every time one of these events rocks our market there is lots of righteous indignation but ultimately market access is granted in a relatively short period of time.

All of those defaults were accompanied by shoddy disclosure which supported questionable practices. In the end however, the price to be paid for those defaults was nothing close to the value of the losses incurred. In that sense, the market has failed. None of these examples are small borrowers. They were each substantial entities, each of whom should have been in a position to provide basic and timely information. Yet they were able to borrow because the buyers allowed them to.

The GFOA has always been in a position of obstruction of real serious logical evolution of municipal disclosure. What they have never been able to sufficiently address is the point that they are government officials which means that everything they do is public business. A government entity is a public entity therefore everything that entity does is public. It’s not that the information needed to meet disclosure is unavailable. It’s that the issuers are unwilling to assemble it or provide access to it.

So in the face of long standing intransigence and opposition, where else was the market supposed to turn? It was Congress under the Tower Amendment that set the legal standards contributing to this mess and it is likely Congress that will have to act to undo the damage. Going forward, a broad market based on good consistent and timely information will be key to addressing the nation’s infrastructure needs. Our market will need to expand its base and its horizons if we want it to play a central role in that process.

Clinging to outdated and parochial notions about how borrowers interact with the market will only hurt those communities most in need of the financing capacity and abilities. That will require a change in mindset on the part of borrowers. But it also must be followed by legislative support at the state level.  

The existing codified reporting structures and requirements are clearly in need of updates (that’s you New Jersey, e.g.). So long as local finance officers are required to develop and maintain reports conforming to state law requirements, our hopes for disclosure that is meaningful and usable will continue to be seen as simply and extra and unneeded expense.

Absent these changes, the National Federation of Municipal Analysts is more than right to seek SEC involvement. The issuers can complain but when they wind up with much more onerous disclosure requirements than currently exist in order to gain access to the public debt markets, they will have no one to blame but themselves.  

AND ANOTHER THING

The SEC has announced a settlement with a municipal bond advisory firm. Clear Scope Advisors Inc. agreed to pay more than $25,000 to settle charges the firm violated the federal securities laws and MSRB Rules G-2 and G-3 by not having its advisors properly qualified. Clear Scope provided municipal advisory services to two issuers without having any municipal advisor professionals who took and passed the Series 50, according to the SEC. The MSRB sent reminders to firms to take the Series 50 exam, which became required on Sept. 12, 2017. All municipal advisors have to pass the test before engaging in municipal advisory activities on behalf of a municipal advisory firm.

Situations like this usually stem from some action by an advisor that hurts an issuer. Interestingly, The MSRB notes that it maintains a list of advisors who have met SEC requirements. The MSRB has been trying to direct issuers to its website to see if their municipal advisor is qualified. As the MSRB Chief Compliance Officer notes, “You can’t stop people who don’t want to follow the rules. They will always be out there, but I’m trying to get issuers to start looking at our website because it’s listed there.” Clear Scope Advisors was not listed on the site because it did not have at least one qualified person.

As for the issuer “victims”? Looking at a website requires no significant expertise, staff, or financial resources. Unlike disclosure, there really is no excuse for not exercising due diligence regarding the people advising you.

INFRASTRUCTURE ANNIVERSARY

Amidst all of the debate and angst over the state of the nation’s transportation infrastructure, an important anniversary passed recently. May 11 was the 150th Anniversary of the Golden Spike Ceremony, marking the completion of the first American Transcontinental Railroad. Within three years of this event, trains could travel from New York City to San Francisco in just one week.  Prior to the completion of the railroad, travelers spent up to six arduous months traveling by ship or covered wagon, often enduring great dangers at great cost.

Projects like the Transcontinental Railroad were an early form of public private partnership. The federal government provided land to the railroads who then undertook the financing and funding and construction of the railroad. Now there were many aspects of the process that were highly troubling in the light of history in terms of the sourcing and use of labor. Frankly, those practices were unacceptable. Today, structures exist to better protect workers and outlaw the exploitation of them as was the case with the Transcontinental Railroad.

All of the positive aspects of such a project could easily translate into a workable P3 concept for financing public capital facilities. Land use regulation, a current regulatory framework, and a financing capability are bought to the table by government. The actual physical execution of the project, its management, and operation are easily within the province of the private sector.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.