WASHINGTON -- Maryland Rep. Tom McMillen has drafted a bill designed to bring billions of dollars to state and local governments for use on infrastructure projects. But some economists say the complex plan may be too circuitous to make the transition from theory to practice.
The Invest in America Act, which Mr. McMillen, D-4th, is planning to introduce later this month, would provide a federal subsidy for IRAs and pension funds that invest in municipal and general obligation bonds.
IRAs and pension funds currently invest little in such bonds because the main advantage in buying them is that earnings are not taxed. IRA and pension plan earnings also are tax-free.
The federal subsidy, Mr. McMillen hopes, would provide an incentive for managers of IRAs and pension funds to put some of their holdings into local and state bonds. Pension funds have exploded in size over the past few years and currently control about $3 trillion dollars in holdings, he said in an interview Thursday.
According to Mr. McMillen, the infusion of money from pension funds and IRAs would drive the current investors in municipal bonds -- mainly wealthy individuals -- out of the municipal bond market and into taxable investments such as stocks.
Taxes on the new investments would wholly or partially offset the cost of the federal subsidy, leaving little or no negative impact on the U.S. deficit, according to Mr. McMillen. The plan could even add to the federal pie by generating income tax from people working on the infrastructure projects, he said.
The success of Mr. McMillen's plan hinges upon its expected effect on interest rates. If pension funds and IRAs entered the market, demand for bonds would increase. The rate of the interest paid by municipalities to bondholders would then plummet by 10 percent, according to James M. Ruth Jr., an independent New York-based economist who helped draft the legislation. This would give local governments an extra 10 percent of the value of the bonds to spend on roads, hospitals, and other projects.
Billions of dollars would be freed in state and local governments across the country, according to Mr. McMillen. In Maryland, the city of Baltimore, which has $416.9 million in bonds outstanding, would have an extra $41.69 million to spend; Baltimore County would save $68.52 million; Anne Arundel $43 million; Carroll $5.43 million; Harford $1.69 million, and Howard County $29.8 million.
Kenneth Mannella, director of the Maryland governor's Washington office, described the plan as "interesting" and "innovative."
"It should lower the cost of borrowing for state and municipal governments. And it would relieve pressure on the tax system because it would lower our interest costs on capital projects," Mr. Mannella said.
But an economist for a Baltimore investment bank was less enthusiastic. Mr. McMillen's plan could boost the amount of money available to state and local governments, the economist said, but there already "are huge amounts of money out there."
Since the Tax Reform Act went into effect in 1986, municipal bonds have been "the only meaningful tax advantaged investment" available to middle- and upper-income people, said the economist, who asked not to be identified. Individuals with money to spare have invested heavily in bonds, he said.
Even more capital will be available over the next couple of years as 10-year bonds issued in the early 1980s are redeemed, the economist said.
The country's "infrastructure crisis," rather than being caused by a dearth of capital, has come about because of federal funding cuts to states and localities, which is forcing those governments to raise their taxes, the economist said.
Brad Fitch, a spokesman for Mr. McMillen, said the bill would not simply bring in more capital but would also improve access to that capital by making it more affordable. The average interest rate on bonds is expected to go from the current 6 percent to as low as 5.25 or 5.5 percent, according to Mr. McMillen.
But the economist said "the difference between 6 percent and 5.25 percent is not going to make a lot of difference in the scheme of things." Interest rates also could go up in the next few months, offsetting the proposed gain, he said.
"Frankly, I don't think that's a very sound analysis," the economist said of the McMillen plan. "There's lots of speculation involved."
James Poterbo, a professor of economics at the Massachusetts Institute of Technology, said the plan raises ongoing questions of market manipulation and efficiency.
"Is this subsidy through the tax code the most natural way to bring more money into municipalities? The obvious alternative would be to channel money to states and localities directly through a federal subsidy," he said.