Tax Exemption for Municipal Bonds Threatened

Tax Exemption for Municipal Bonds Threatened

As Congress and the Obama Administration consider how to avoid the looming "fiscal cliff," one item on the table could result in higher borrowing costs for city governments.  Some congressional leaders are pushing to eliminate the tax exemption for municipal bonds, which would lead to higher borrowing costs for major infrastructure projects.

Congress is considering changes to the Internal Revenue Code to simplify the Code and remove certain perceived "loopholes," which could possibly include the elimination or limitation of tax-exempt municipal bonds.  Municipal bonds are a proven, effective way to provide funding for public infrastructure and the related benefits to the national and local economies from job creation and business development.

Kentucky cities reported over $244 million in bond revenues in FY 2011 alone.  Because interest on municipal bonds is not taxed by the federal government, political subdivisions are able to borrow at lower rates of interest and taxing municipal bond interest would increase the cost of borrowing.  Eliminating or reducing the tax exemption could drive up cities' borrowing costs by one to two percent because cities will need to pay more interest to compete with other taxable investments.

Congress exempted municipal bond interest from federal income taxes in 1913.  In 1986, the exemption was limited to public-purpose bonds, and many bonds issued for private activities were subjected to the alternative minimum tax.  In 2010, the National Commission on Fiscal Responsibility and Reform proposed making interest taxable as income for newly issued bonds.  The Joint Committee on Taxation last year estimated that eliminating the tax-exempt status would raise $124.4 billion over a decade.