PrefBlog

The Congressional Budget Office has released a major report on budget options for Congress. Among the more interesting are:

• Reduce the Mortgage Interest Deduction or Replace It with a Tax Credit
• Replace the Tax Exclusion for Interest Income on State and Local Bonds with a Tax Credit

The second alternative [converting the mortgage interest deduction to a credit] would replace the deduction with a 15 percent tax credit for interest on mortgages below the declining limits in the first alternative. (In 2005, the President’s Advisory Panel on Federal Tax Reform proposed a variant of that approach.) The change would reduce taxes for some owners and raise them for others, with a net increase of $13 billion in 2013 and $388 billion over the period from 2013 to 2019.

Creating a tax credit for the interest paid on state and local debt could have several advantages. First, it could lower states’ and localities’ borrowing costs by about the same amount as the current tax exclusion but cause a smaller reduction in federal revenues. The reduction would be smaller because switching to the credit would prevent bondholders in higher tax brackets from receiving gains that exceeded the investment return necessary to induce them to buy the bonds. Second, the size of the tax credit could be varied to allow lawmakers to adjust the extent of the federal subsidy—on the basis of its perceived benefit to the public—for different categories of borrowing by state and local governments. (Even with a tax credit, however, the federal subsidy would remain akin to an entitlement; that is, it would not automatically be subject to annual Congressional scrutiny.)

Good ideas, but I don’t think they’ll go anywhere until Treasury reports a significant risk of bond auction failure.

How ’bout that preferred share market, eh? PerpetualDiscounts dominated the volume table while roaring up another 60bp today, taking their yield down to 5.63%, equivalent to 7.88% interest at the standard equivalency factor of 1.4x. Long Corporates now yield 6.0% – well, maybe just a hair less – so the pre-tax interest-equivalent spread is now 188bp, a decisive break through the ‘credit-crunch-normal’ level of about 200bp and considerably tighter than the 215bp recorded on August 12.

This entry was posted on Wednesday, August 19th, 2009 at 8:41 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.