In June’s Governing Magazine, columnist Girard Miller discusses federal legislation introduced to reform federal tax treatment of municipal bonds. Under current law, federal taxes do not apply to income received from municipal bonds, allowing state and local governments to borrow at substantially lower interest rates and still remain attractive to investors.
Under a proposal by U.S. Sens. Ron Wyden, D-Ore., and Dan Coats, R-Ind., muni bond issuers would lose the tax-exempt status of their bonds, but instead receive a federal subsidy to lower their interest rate cost. The theory behind this “mandatory taxable bond” policy is that the federal government loses billions of dollars every year in income taxes evaded by super-rich investors and large insurance companies that invest in muni bonds. So it would be better to subsidize states and localities directly, as Congress did with Build America Bonds — known fondly as BABs. Very few municipal bond issuers now sell their paper at an interest rate below the proposed subsidy level, so the economics could make sense on the surface — if Uncle Sam could provide an irrevocable promise to pay its share, which we all know it cannot.