Municipalities Fight a Proposal to Tax Muni Bond Interest

The average annual property tax bill in his affluent suburban Washington county would ultimately rise by at least $100, he estimates, as a consequence of a proposal by the Obama administration to modestly tax the interest that wealthy investors receive from municipal bonds. That’s because, he says, if investors see less of a tax break, they will demand higher interest to make up the loss, and higher interest rates will mean higher borrowing costs for governments.

Mr. Firestine is on the front lines of a lobbying campaign by local and state governments, bond dealers, insurers and underwriters that is trying to pre-empt any attempt to limit or even kill the tax exemption. The administration has proposed capping the tax break that America’s highest earners now receive from municipal bonds, as part of its campaign to close loopholes and enlist more of the rich in fighting the federal deficit. Analysts expect such a cap to be part of a comprehensive tax overhaul package that Congress will take up next year, under a broad fiscal framework now being negotiated by President Obama and House Speaker John A. Boehner.

“This is the most serious threat to tax-exempt bonds since Roosevelt, in the late 1930s, tried to repeal the exemption across the board,” said John L. Buckley, a professor of taxation at Georgetown University and former chief counsel to the House Ways and Means Committee.

At present, the federal government forgoes about $32 billion a year in taxes by exempting the interest that investors earn from municipal bonds.

A wealthy couple in the highest tax bracket who receive $100,000 a year in municipal bond interest currently pay tax on none of it, effectively lowering their total tax bill by $35,000 under the current rates. But under the administration proposal to limit tax breaks for households whose taxable income is more than $250,000, the same couple would see the savings on their tax bill reduced to $28,000, effectively resulting in a $7,000 tax payment. (People in lower tax brackets would not be affected by the change.)

There are other proposals for taxing muni interest. The National Commission on Fiscal Responsibility and Reform, known as the Simpson-Bowles commission, has suggested taxing all municipal bond interest, not just the interest paid to people in the top bracket. Other experts have suggested taking the exemption away from municipal bonds that raise money for business, while still allowing it for bonds that finance public works.

Mr. Firestine, the president-elect of the Government Finance Officers Association, has been following developments, through conference calls arranged by the White House, and calling members of Congress.

Officials of some other government groups, like the New York City Housing Development Corporation, have formed a coalition with Wall Street groups like the Bond Dealers of America to lobby on the issue. But there is the sense of an uphill battle. Last week, Mr. Boehner said he accepted Mr. Obama’s proposal to limit various tax deductions and exemptions to the value now received by people in the 28 percent bracket. By implication, that includes municipal bonds.

President Obama’s proposal would not “grandfather” existing bonds, but would apply to all of the $3.7 trillion worth of municipal bonds now outstanding, most of them held by individual investors, directly or through mutual funds.

High-bracket investors who hold them would have to start paying an effective tax of 7 percent of the interest — or even more if the highest tax bracket increases from the current 35 percent.

“This would be the first time that a tax law has affected existing debt,” said Chris Mauro, head of municipal bond strategy at RBC Capital Markets.

Investors are anxious because they bought the bonds, often issued for 20 to 30 years, in the expectation that they would be tax-exempt until maturity.

Article source: http://www.nytimes.com/2012/12/20/business/municipalities-fight-a-proposal-to-tax-muni-bond-interest.html?partner=rss&emc=rss