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1 Scott Greenberg, Reexamining the Tax Exemption of Municipal Bond Interest 1 (2016)

handle is hein.taxfoundation/retxmpmub0001 and id is 1 raw text is: TAXS FOUNDATION FISCAL FACT No. 520 July 21, 2016 The Tax Foundation is the nation's leading independent tax policy research organization. Since 1937, our research, analysis, and experts have informed smarter tax policy at the federal, state, and local levels. We are a 501(c)(3) non-profit organization. @2016 Tax Foundation Distributed under Creative Commons CC-BY NC 4.0 Designer, Dan Carvajal Tax Foundation 1325 G Street, NW, Suite 950 Washington, DC 20005 202.464.6200 taxfoundation.org Reexamining the Tax Exemption of Municipal Bond Interest By Scott Greenberg Analyst Key Findings: * Since the enactment of the federal income tax in 1913, interest on state and local bonds has been excluded from taxation. However, the original reason for this exclusion - concern about the constitutionality of taxing the borrowing power of state and local governments - is likely no longer applicable. * The strongest economic justification for the tax exemption of municipal bonds is that it encourages state and local governments to invest in infrastructure projects that create benefits for nonresidents. On the other hand, there is also reason to believe that the tax exemption will cause municipalities to overinvest in infrastructure, particularly if states and localities are also able to shift their tax burdens onto nonresidents. * A tax exclusion is an unideal policy design for subsidizing state and local debt: it delivers larger benefits for taxpayers in higher income brackets, shuts some investors completely out of the municipal bond market, and makes the subsidy difficult for Congress and voters to evaluate. * Most importantly, there is a compelling case that the current tax treatment of municipal bond interest is inefficient. For every dollar that the federal government forgoes due to the provision, state and local governments receive less than a dollar in lower borrowing costs; the remainder goes largely to high-income households.

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