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“Municipal bonds enable state and local governments to build essential infrastructure projects, such as schools, hospitals and roads,” The National Association of Counties helpfully reminds readers in a recent pitch to preserve the tax-exempt status of municipal bonds.
Congress and the administration are currently debating federal tax reform, including a cap or a repeal of the tax-exempt status of municipal bond interest. The group’s analysis of the municipal bond market and of the estimated impact of a 28% cap and a repeal of their tax-exempt status on the 3,069 county governments reveals that:
- Municipal bonds have a long history of low default rates. Between 2003 and 2012, counties, states and other localities invested $3.2 trillion in infrastructure through long-term tax-exempt municipal bonds, 2.5 times more than the federal investment. In counties, the legislature of the county government has to approve a bond issuance, and often voters also approve the bond financing. Municipal bonds maintain a track record of low default rates, better than comparable corporate bonds.
- American households hold almost three-quarters of the municipal bond market, for retirement plan diversification and as a way to invest in their communities. A cap or repeal of the tax-exempt status of municipal bond interest would deeply affect Americans' retirement nests and asset formation. At the same time, the higher debt service would impact counties and other state and local governments' budgets, and directly affect taxpayers.
- In 2012 alone, the debt service for counties would have risen by $9 billion if municipal bonds were taxable over the last 15 years. Large counties (those with more than 500,000 residents) would have borne more than half of the cost, and small counties would have been most at risk to lose access to the municipal bond market. On a larger scale and longer time horizon, counties, states, localities and state/local authorities would have paid $173.4 billion more in interest between 2003 and 2012 with a 28% cap on the benefit of their tax-exempt municipal bonds for the 21 largest infrastructure purposes in the last 10 years. The cost would have soared to almost $500 billion in case of a repeal of the tax-exempt status of municipal bond interest during the last decade.
The tax exemption of municipal bond interest from federal income tax represents one of the best examples of the federal-state-local partnership, they argue.
“Because of the federal tax exemption, investors are willing to buy municipal bonds that pay less interest relative to other securities.”
With a cap or a complete elimination of the exemption, the group says, investors will want to receive greater interest payments, which would be borne by the counties, states, localities and state/local authorities. Finally, all Americans, as taxpayers securing the payment of municipal bonds, will incur the cost.
Check out 5 Reasons Muni Bonds Will Outperform in 2013 on AdvisorOne.