Obama Proposes Taxing Municipal Bond Interest

Municipal bonds are bonds issued by city and county governments. Bondholders receive interest from the issuers, which is excluded from income by the federal government. Moreover, if a resident of Georgia owns bonds issued by a Georgia city, such as Gainesville, the interest income is excluded for state purposes, too. President Obama's Jobs Plan proposes to limit, and possibly completely disallow this important tax break for higher income earners, a proposal that could spell trouble for city and county governments across the nation as bond sales could stagnate.

Muni bonds receive tax favorable treatment in order to accomplish a civic goal. Because local government bonds pay a lower rate of interest, the exclusion of income for the interest helps promote the sale of these bonds, which benefits the local community. After all, the funds are used by local government for infrastructure. The community receives a big benefit, including those in the lower income stratum. In comparison, regular corporate bonds pay a higher rate of interest, but the income is taxable. The exclusion of income for the muni bonds is supposed to level the investment playing field.

If this proposal is written into law, local government bonds will no longer be attractive to investors. To stimulate the market for these bonds, cities will need to increase the interest rates to be competitive with typical corporate bonds. As a result, cities will pay more interest on the bonds that they manage to sell, the result of which will provide less money for infrastructure, not more. Local governments will have less funds with which to help the working class, which runs at cross purposes with the intent of the bill proposed.

Now, a counter-argument to this point will be that the revenues raised from the change to the rule will be used to help fund local projects. In other words, though local governments may have a shortage of willing investors, the federal government will make up for it with the new revenue by giving it to cities and counties to fund infrastructure. Historically speaking, the aforementioned scheme has never been very cost effective. Simply put, the federal government does not make the best use of tax dollars, a limited and precious resource.

Finally, this proposal would further centralize power in DC and likely infuse the process with inequality as those with the power to disseminate the funds could fall prey to favoritism, cronyism, or any other -ism you can think of.  Why not let the market continue a more effective and better utilization of limited resources without all of the federal intervention? At best, there will be less money at the local level with which to fund projects.  How will this provide for more jobs?