Cut Inflation Act tax incentives could reshape municipal market

The tax incentives provided by the Inflation Reduction Act have the potential to reshape the municipal bond market by undermining its reliance on tax exemption.

This is the thesis of Justin Marlowe, professor-researcher at the Harris School of Public Policy at the University of Chicago, author of an article on the subject which will be published this month in the bimonthly magazine of Government Finance Officers. Association, Government Finance Review, which he previewed Thursday at a Volcker Alliance briefing on the Cut Inflation Act.

Justin Marlowe, a professor at the University of Chicago, Harris School of Public Policy, says the tax credits available to public entities in the Inflation Reduction Act could incentivize a shift away from tax-exempt bonds. tax.

Signed into law by President Biden on August 16, the IRA features a long list of tax incentives for public and private entities to fund clean energy projects. Among the incentives are direct payment tax credits and the ability to transfer tax credits, both of which benefit public entities that are not subject to tax.

The products aren’t new to muni participants, but a significant increase in their supply could affect the market, Marlowe said.

“It begs the question of what will happen if we see a whole range of successful new assets being built using this creative new funding? And if we expand that beyond clean energy, into infrastructure transportation or basic infrastructure like buildings? asked Marlowe. “The success of many large-scale projects [could create] the impetus to view the municipal bond market as a direct-pay tax credit market,” with less emphasis on tax exemption.

That’s something some congressional lawmakers have advocated, Marlowe added.

The IRA offers two types of direct payment tax credits: an investment tax credit, based on a percentage of the cost of a project, and a production tax credit, which is a payment annual based on the quantity of energy produced and sold by a project over a period of 10 years.

“Direct payment plus credit transferability have even bigger implications for where the municipal finance industry goes from here,” he said. The combination of the two creates “a variety of interesting scenarios”.

Renewable energy developers and public entities – like cities, states or public pension funds – could work together to take advantage of IRA tax credits, he said.

For example, a developer could leverage the tax credits to build a solar farm and then sell the project to a public entity, which can convert the tax credits into direct pay credits. Then the entity could “turn around and lease that same asset back to the developer, and the developer could resell the power” using different tax credits to a public entity.

Past direct-payment bond programs, like Build America Bonds, have come under criticism because Congress has been willing to suspend appropriations for deficit reduction purposes. This political risk can be mitigated if the tools reach “critical mass”, Marlowe said.

“There is a very good chance with the IRA that we could reach that critical mass, and that would mean big changes in the way we think about the municipal finance market and how we finance infrastructure,” he said. declared.

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