WASHINGTON — President Obama announced the framework of a plan Wednesday to shrink the deficit $4 trillion over 12 years, and urged House and Senate leaders to appoint teams to negotiate a final bipartisan plan by the end of June.

Obama’s plan would rely on tax-code changes and reforms for a savings of $1 trillion over the 12-year period. The broad initiatives the president laid out — expiration of the Bush income tax cuts for the wealthiest and capping itemized decisions at 28% for high-income households — would benefit municipal bonds, according to market participants.

“That’s bullish for munis,” said Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management.

The higher the effective marginal tax rates, the greater the value of tax-exempt bonds. Ciccarone noted that the top income tax rate went north of 70% after the Great Depression because the government needed to cut the federal deficit. Limits on tax deductions also would make munis more attractive because tax-exempt interest is an exclusion rather than a deduction from income taxes.

The proposals came in Obama’s fiscal 2012 budget request.

On the other hand, the president said he would like to “build on” his federal deficit commission’s model for reducing tax expenditures.

The National Commission on Fiscal Responsibility and Reform, which was led by Erskine Bowles, former chief of staff to President Bill Clinton, and former Sen. Alan Simpson, R-Wy., posed the idea of doing away with tax exemption for new munis.

“That’s a tougher sell,” Ciccarone said.

But market participants said that in the current environment there appears to be a predisposition to eliminating tax preferences for the wealthy.

A number of recent reports have called for curbs on tax-exempt bonds. The Progressive Policy Institute this week released a tax reform plan that would eliminate tax-exemption for new munis.  In November, the Bipartisan Policy Center’s debt reduction task force released a report that would maintain the tax-exemption of interest for public-purpose state and local bonds, but eliminate it for new private-activity bonds such as housing, hospital, and small-issue development bonds.

In addition to revenue gains from tax reform, Obama’s deficit reduction plan also calls for cuts over 12 years of $750 billion from non-security discretionary spending; $400 billion from spending for security, including defense; and $480 billion from health care. Another $360 billion would come from federal pension, agricultural and other reforms as well as from the expected reduced interest costs on the federal debt.  

Obama’s plan would include a “debt fail-safe” mechanism under which if the nation’s debt was not projected to fall as a share of the economy by 2014, across-the-board automatic cuts in direct spending and spending through the tax code would be triggered.

“This would be an incentive for us to act boldly now, instead of kicking our problems further down the road,” he said.

The president drew distinctions between his plan and the one put forth by the Republicans, which would reduce the deficit by $4 trillion over 10 years. The GOP plan, he said, would make unacceptably large cuts in domestic programs, including education and clean energy, provide $1 trillion in new tax breaks for the wealthy, and turn Medicare into a voucher program that would leave seniors at the mercy of insurance companies.

But Republicans criticized the Obama plan for being partisan and for not going far enough.

House Ways and Means Committee chairman Rep. Dave Camp, R-Mich., said: “I’m disappointed the speech was so partisan. That said, the president deserves credit for acknowledging his budget didn’t go nearly far enough in getting Washington spending under control. However, his proposal to raise taxes on the American people by more than $1 trillion would be devastating for our economy and job creation. Higher taxes aren’t the solution; they’re just a greater burden Washington would put on families and job creators. Despite the president’s claim that tax hikes will only hit those families defined as 'fortunate,’ the reality is that the tax hike would hit half of all small business income. We need those small businesses paying more employees, not paying more in taxes.”

Sen. Orrin Hatch, R-Utah, the ranking minority member of the Senate Finance Committee, said: “Today, the president tried a do-over. He was going to give a really big speech. That seems to be his go-to move. And this time he was going to convince Americans that he is really, really serious about deficit reduction. Unfortunately, he bricked this shot as well. We are approaching a debt crisis, but the president seems willing to run the clock until the next election.”

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