Tax-Free? Hmmm

What are the odds that the Federal Government will begin taxing municipal bond interest?

Ever since President Obama proposed his $477 billion job-creation plan, that has been a question that is being asked. On page 136 of the 155 page bill, there is mention of limiting (not revoking all together) the tax break for municipal bond interest. Right now it sits in the hands of the bi-partisan “supercommittee” which has until November 23rd to come up with $1.5 trillion in a combination of spending cuts and revenue increases.

The proposal in it’s original form would still give full exempt status to taxpayers in the 28% tax bracket or lower. It would however, partially tax municipal interest to those in the tax brackets higher than 28%. It would not go into effect until 2013.

There’s healthy skepticism of this passing in its current form. The muni markets have not shown any weakness in the face of this proposal, in fact, intermediate term muni funds saw net inflows of $851 million over the past 8 weeks. Also, organizations such as the National League of Cities and the Government Finance Officers Association will surely oppose any move to limit the tax exemption for municipal securities. Limiting the amount of tax-exempt interest that can be deducted would likely affect demand for muni bonds and therefore increase debt costs for all governments (cities, counties, states) who need access to the bond markets. Increased borrowing costs would end up hurting local taxpayers because it would raise the cost of borrowing just when municipalities need that cost to stay low.

State and Municipal Finance professionals recently polled at a conference showed 71% believe no changes will occur, while 27% believe there will eventually be some partial taxation. We are with the majority and believe that it’s very unlikely that this proposal will gain the required traction to become law. We’ll continue to monitor the situation as the supercommittee continues its meetings over the next several weeks.

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