Obama May Limit Tax Breaks on Muni Bonds

[Freddie Stubbs]

Source: Bloomberg

President Barack Obama proposed curbing the amount of interest from municipal bonds that top earners can exclude from their taxable income, a step that may diminish demand for state and local-government securities.

The president’s $447 billion job-creation plan would pare the tax break for municipal-bond interest to 28 percent for couples earning more than $250,000 a year. Such tax-exempt interest is currently worth 35 percent for earners in the top tax bracket because that’s the amount they would otherwise have to pay on their income.

Any move to limit the tax advantage for municipal securities would face resistance from local-government officials because the break bolsters demand for their debt, lowering the interest rates they pay when borrowing for public works. Investors in the $2.9 trillion market for municipal bonds are willing to accept lower returns because the income isn’t taxed.

“We’re very much opposed” to limiting the tax exemption, said Mike Nicholas, chief executive of the Bond Dealers of America, a Washington-based lobbying group for banks that underwrite municipal bonds. “You’re going to end up punishing state and local governments.”

Read more: http://www.bloomberg.com/news/2011-09-12/obama-jobs-plan-proposes-limits-on-tax-breaks-for-municipal-bond-investor.html

[Cool Logic]

1. Making investments less attractive, means less investors...

Likewise, a larger % of a smaller pie, may mean less $ collected.

[dkf]

2. Investors look at the after tax yield anyway so they don't have to stay with Munis.

It's the states and municipalities that will land up paying more in interest costs.

This is really a transfer from the states and municipalities to the Federal Government.

But that is all we need...more uncertainty hanging over things.

[zogofzorkon]

13. Its also a transfer to homeowners who will pay higher local taxes

That should certainly help w/ the sale of existing homes and help pass bonds to pay for repair of schools, roads, water supplies and other wasteful local infrastructure.

[No Elephants]

3. Good. Bloomberg should have written

a step that may SOMEWHAT diminish demand AMONG WEALTHY PEOPLE for state and local-government securities.

The President is not proposing to eliminate the tax advantage of investing in state and local government securities, only proposing to reduce the tax advantage of collecting interest on those bonds, and only as to wealthy investors.

Sounds fine to me.

[Xithras]

8. Wealthy investors make up the majority of the muni bond market.

Muni bonds have low interest rates and long terms, and aren't very appealing to smaller investors. If you have ten million dollars and want to park it somewhere safe, sticking it into a 20-year AA bond at 4.5% seems like a reasonable way to protect it, and the tax free yield on that kind of investment is sufficient to make it worthwhile.

If you don't have that kind of money, or 20 years to lock it away, they aren't worthwhile at all. The current rate on a 2Yr AA muni bond is 0.41%. The 2Yr rate on an AA corporate bond is 0.95%. Both are crap, but if you're going with bonds on the timescales and at the budgets of smaller investors, only nitwits would choose muni bonds.

They only have appeal, AT ALL, because of the tax exemption. If it's removed, even partially, they'll have to raise their rates compete against corporate bonds. That move will cost state and local governments, and local school districts, tens of billions of dollars every year (remember, the feds only get to tax a small percentage of the yield, but local governments have to pay out ALL of it). Every additional penny taken by the federal government is an extra penny that local government agencies will have to pay to private investors just to stay competitive.

This is a tax transfer from state and local governments to the federal government. Nothing more.

[dixiegrrrrl]

21. an excellent explanation.

Thank you.

[Psephos]

25. Most munis are bought by mutual funds, investment funds, and pension funds.

Small investors (usually through an IRA) have an easy way to buy them through shares of bond mutual funds.

You made some very good points in your post, and your conclusion is spot-on.

[Owl]

15. Good. Sounds fine to me also.

[cstanleytech]

19. From what others are saying on the thread though i get the feeling its actually not such a good idea

because it will (according to them and assuming I am reading it correctly) actually hurt the local governments by discouraging people from buying the bonds.
Now imo what obama and the democrats really should press for is for the inheritance tax to be put back into place as well as closing the current tax loopholes.

[Xithras]

4. This isn't good.

These bonds fund everything from road projects to school construction. The high speed rail system being developed here in California is primarily funded through municipal bonds. If the tax exemption is lifted, those agencies will have to increase the interest rates offered on those bonds, which will increase the amount of interest debt they are forced to pay annually, forcing them to cut their budgets elsewhere.

It's not even an exaggeration to say that cutting the muni bond exemption will lead to teachers, police, and firefighters losing their jobs. It will also greatly reduce the amount of funding that local governments have available for projects, which will increase unemployment (in many rural areas, government agencies are among the largest employers).

Who thought this was a good idea??

[hugo_from_TN]

5. Everyone on DU who wants to eliminate tax breaks for the evil rich.

That's who thinks it is a good idea.

I think this proposal is reasonable. People still will get a good tax break on Munis, but yes, the local govts will probably need to pay out a bit higher rate to compensate for the reduced deduction at the fed level. TANSTAAFL

[dkf]

7. Exactly. This is really a "get the rich" bill.

Its just political warfare against the Republicans

[Cassandra]

10. There's something wrong with...

political warfare against Republicans?

[Freddie Stubbs]

12. There's something wrong when local governments have to pay the price for it

[dkf]

17. Depends if you want a bill that will get passed or not.

Personally I think he has given up trying to create jobs and improving the economy. Now its just trying to convince the public that he made an effort and placing the blame on the Republicans when nothing happens.

[24601]

27. If you don' believe to wage any kind of warfare against any American,

then you shouldn't complain if/when it's waged against you.

Elected officials are supposed to represent all their constituents, not just those that think like they do.

And if you lose the independents, you lose everything, period.

[kelly1mm]

22. Since others have written above that the "evil rich" are the majority

of muni bond investors and that they base their investment choices on after tax yield, the winners and losers of this proposal would be:

1) Federal government - Winner, a bit more income tax revenue.
2) "Evil rich" - Neutral, the interest rate paid by states/local government will have to rise to make the after tax yield as attractive as it is now.
3) States/local governments and their taxpayers - Losers, they will have to pay higher rates of interest to attract investors who look at after tax yield.

Not a good idea in my view.

[dkf]

6. It's making me think this is purely political posturing.

Anything they can think of to tax the rich without thinking through consequences.

[JCMach1]

26. Exactly... very bad.... of all the deductions to go after, let's take the one that

will hurt pensions and local governments the most.

[madrchsod]

9. that is thee worse idea that he`s come up with.

i can`t believe he`s that stupid.

[sulphurdunn]

11. This is how you create jobs

while you fix and update the nation's infrastructure: You increase the cost of borrowing to state and local municipalities for fixing and updating it. Brilliant! :crazy:

[galileoreloaded]

14. This guy is worse than Hoover, as Hoover really had nothing to learn from

but Obama does.

This is dumber than banning short sales, and will strip liquidity from local government. Let a few muni auctions fail, and this idea will go the way of the Dodo.

Wow.

[joeglow3]

16. Expect states to begin taxing interest on US Bonds

This will kick off a nice pissing match between the states and the Federal government.

[dkf]

18. The thing is once you cap it you open up the possibility that none of it will be exempt.

Therefore why would you buy longer term munis?

Anyone who buys munis needs to take into account political risk from now on.

I think simply floating this proposal with make people think twice about munis.

[RUMMYisFROSTED]

20. Muni's V. Capital Gains

Weird stance for a "Dem."

:think:

[Yupster]

23. Well the stock market's in trouble

Might as well hurt the muni bond market too.

If investors are too scared to invest anywhere maybe they'll buy new cars instead and get the economy moving again.

[christx30]

24. Or they will just put their money

into an overseas bank that is still paying interest.
So what are local governments going to do when no one will invest in their bonds? They'll just raise local taxes. Fines are going to go up. Roads won't be maintained as well as they were cause the money just isn't there.


If you want people to invest in your home town, you have to give them a reason. Like making it a safer place to invest their money.
Obama wants to take away that reason.