Municipal bonds a little too attractive?

Here’s a page 16 story that might be working it’s way to the front.

It’s a wonder that municipal bonds are still largely tax free.  Some states tax residents for income generated on other states’ bonds, while others further attempt to funnel funds by only exempting home-state bonds from state tax if they’re from certain types of municipalities.  Still, the big tax savings comes from the bonds being exempt from taxes at the Federal level.

Bloomberg featured a story (below) on a CBO proposal to capture some tax revenues that might be had were the bonds taxable.  Here would be the results:

  1. Higher borrowing costs for municipalities, which means . . .
  2. Higher taxes to cover the borrowing costs; and
  3. More tax revenues from that favored target demograpic, “bondholders in higher tax brackets,” because they receive gains, “that [exceed] the investment return necessary to induce them to buy the bonds.”
Let’s Kill the Tax-Exempt Municipal Bond Market: Chart of Day

2009-08-19 10:00:00.0 GMT

 By Joe Mysak

Aug. 19 (Bloomberg) — The tax-exempt bond market costs the U.S. government $36 billion a year in forgone taxes. Replace the exemption with a credit and the government would lose less.

That’s the contention of the Congressional Budget Office, which suggested the change in its latest volume of options for altering federal spending and revenue.

Taxable interest payments would be offset by a federal tax credit, whose amount would be determined by the Treasury. The credit would change with the type of bond “on the basis of its perceived benefit to the public,” the CBO said in its report, whose options derive from a variety of sources, including legislative proposals and the president’s budget.

The tax credit might yield a smaller reduction in federal revenue than the current system. Opponents maintain that it could “raise the interest rates that state and local governments pay on borrowed funds,” the budget office said.

Earlier this year, the government introduced the Build America Bonds program, which pays municipal issuers 35 percent of the interest cost if they sell taxable rather than tax-exempt debt. The federal subsidy results in borrowing costs to the issuer even lower than those available in the tax-exempt market.

Since April, $22.6 billion in Build America Bonds have been sold as against $202.5 billion in tax-exempt bonds.


If you’re so inclined, you can click here to read the CBO’s 284-page, Budget Options Volume 2, August 2009.  Skip over to page 229 for more on the muni bond revenue scheme.  On second thought, I wouldn’t suggest looking at this tome unless you’re into nightmares.


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