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House tax plan would mean higher borrowing costs for hospitals, schools, affordable housing

Hospitals, university buildings and affordable housing projects could become markedly more expensive to develop if the tax plan approved Thursday by the Republican-controlled House of Representatives becomes law.

The plan calls for eliminating a tax break on a type of bond financing used to build those and other projects, prompting worries by hospitals, colleges and housing groups that they could be forced to cut services, raise prices or cancel projects. They’re hoping the Senate tax plan, which does not eliminate the tax break, comes out on top.

Nonprofits and affordable housing builders are able to borrow money by selling so-called private-activity bonds, which share a key feature with municipal bonds issued by government agencies to finance public projects: The interest income paid to bondholders is not subject to federal or state income tax.

Because of that tax exemption, investors are willing to buy bonds with a lower interest rate, which means lower borrowing costs for bond issuers.

The House tax plan, by eliminating the federal tax exemption, would raise borrowing costs for new private-activity bonds.

Though the bonds are sometimes used by for-profit business to build public-private projects such as toll roads, in California the vast majority of this type of financing is used by hospitals, affordable housing developers and private universities.

Over the last 10 years, entities in California have issued about $49 billion in private-activity bonds. The biggest borrowers have been hospitals and medical centers, which have taken out more than $19 billion in bond debt to build new facilities, retrofit old ones and buy new equipment.

California Treasurer John Chiang, who is running for governor and whose office oversees the issuance of tax-exempt bonds, sent a letter this month to House Majority Leader Kevin McCarthy (R-Bakersfield), highlighting the effect of the tax plan on affordable housing projects. But he told The Times that the plan would cause other harm as well.

“I think it’s incredibly shortsighted,” Chiang said. “We’re trying to expand the economy, and these sectors are critical to California’s well-being.”

McCarthy, California’s highest-ranking Republican and a key supporter of the tax plan, did not respond to a request for comment.

The California Hospital Assn. estimates the change could add billions of dollars in added interest costs for hospital construction and seismic retrofitting projects, and the California Housing Consortium said the change could cut the number of affordable housing units built in the state each year by two-thirds.

Investment bankers and finance officers at nonprofits estimate the loss of the tax exemption could push up interest rates on private-activity bonds by 0.5% to 1.5% — a significant sum when the principal typically runs from the tens to the hundreds of millions of dollars.

Consider Keck Graduate Institute, one of the Claremont Colleges, which this year borrowed $52.6 million to build a 290-unit apartment building for students. The institute is paying about 4.7% interest on that private-activity debt.

Hugh Tanner, an investment banker at Raymond James who helped put the bond offering together, said Keck would have paid more like 5.7% if it had to issue taxable bonds. Over the 30-year life of the bond, that extra 1% would add up to a total of $14.8 million in additional interest, he said.

Those higher borrowing costs would trickle down to students. The institute plans to charge $1,360 for studios — below average for Claremont — but Tanner said rents would have to have been closer to $1,500 a month had Keck borrowed at the higher, taxable rate.

“In the end, this is saving students time and money,” said Michael Jones, Keck’s vice president of finance and operations. “Using these bonds is one way to get costs as low as we can for these students. They already pay enough in tuition, and we already need to fundraise to cover our operations.”

Kevin DeGood, director of infrastructure policy at the liberal advocacy group Center for American Progress, said cutting the bonds’ tax exemption would hurt nonprofits across the country while providing little extra tax revenue.

The Joint Committee on Taxation, an arm of Congress, estimated that cutting the exemption would result in additional federal tax income of $39.8 billion over the next 10 years — a meager sum considering that the committee also estimates the tax plan as a whole will result in an overall reduction of federal tax income of $1.4 trillion over that period.

“If you’re a hospital, the additional interest you pay if your bonds are taxable has to come out of donations, out of patients, out of somewhere,” DeGood said. “There is no benefit to anybody to make it more expensive for a hospital to build a new wing. There is not a rational policy argument here. This is about hunting in the night for revenue to pay for egregious tax cuts.”

The threat of losing tax-exempt borrowing is especially worrisome in California, where hospitals are spending billions of dollars to build and retrofit facilities to meet strict new earthquake-safety standards by 2030, said Anne McLeod of the California Hospital Assn.

“That tax-exempt rate is potentially the difference between being able to maintain services and having to cut services,” she said.

Richard McKeown, corporate vice president and treasurer at San Diego nonprofit Scripps Health, said the hospital group plans to spend $2.6 billion on capital projects over the next 10 years, with nearly a third of that amount financed with bonds.

If tax-exempt bonds are no longer an option and Scripps’ borrowing costs go up, McKeown said it would not be an “insurmountable issue” but would probably require some cost cutting.

“It’ll be painful, but it won’t be catastrophic for larger, financially strong organizations,” he said. “Small community hospitals that may not be doing OK financially, the additional burden of a higher cost of debt will make it more challenging.”

Private schools, too, could be pinched by higher borrowing costs.

Over the last 10 years, private colleges and universities in California — including USC, Pepperdine, Stanford and a host of smaller schools — have borrowed $4.1 billion through private-activity bonds to build all manner of campus projects.

California Baptist University in Riverside used tax-exempt bonds for an events center and sports arena. Biola University in La Mirada used them for a new 350-bed dormitory.

For affordable housing developers, who rank second only to hospitals in their use of private-activity bonds, the idea of paying higher interest rates is a secondary concern. Their biggest worry is that if these bonds become taxable, the change would have the secondary effect of killing one of the biggest funding sources for affordable housing projects: low-income housing tax credits.

There are two types of those credits, both of which give tax breaks in exchange for investing in affordable housing projects. One of the types of credits, though, is available only to projects that are financed mostly with tax-exempt bonds. No tax-exempt bonds means a whole class of tax credits would effectively disappear.

Chiang’s office reported that in 2016 alone, California affordable housing projects used $6 billion in private-activity bonds and received $2.2 billion in tax credits linked to those bonds. That helped build or preserve 20,600 affordable units.

Will Cooper Jr., chief executive of Irvine affordable housing investment firm WNC Inc., estimated that the combined loss of tax-exempt bonds and the related tax credit program could reduce the number of affordable housing units built in California by 200,000 over the next decade.

Cooper said he’s been lobbying Republicans in Congress and believes that private-activity bonds will ultimately remain tax exempt.

“We believe the Senate bill, which leaves [private-activity bonds] as they are, will carry the day,” he said. “We're going to continue to push. Republicans are willing to put this back on the table.”

james.koren@latimes.com

Follow me: @jrkoren

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