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Muni Bonds: How Killing a Tax Break for the Rich Could Hit Everytown, U.S.A.

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Republicans in Congress and President Obama remain locked in their seemingly interminable debate over how to avoid the fiscal cliff of tax increases and spending cuts set to befall us at the end of the year. As they've tried to break the stalemate, lawmakers have looked at a variety of proposals to raise revenue, among them, ending certain tax breaks and exemptions.

One particular tax break that has gotten more attention recently is the exemption for municipal bond interest. However, while it's easy to pitch muni bonds as a tax dodge for the rich, eliminating the tax break could cost local governments a fortune in higher borrowing costs.

The Scoop on Muni Bonds

Municipal bonds are bonds that state and local governments issue to raise money for public projects.

Ranging from general obligation bonds, the money from which states can use on whatever they choose, to more specialized bonds sold specifically to finance such things as sewers, hospitals, and school construction, muni bonds help governments bridge the gap between their immediate needs and the future revenue with which they'll be able to pay for them.

To encourage investing in munis, the U.S. tax code makes the interest they pay exempt from federal income tax. If you buy munis issued within your state, you won't have to pay state income tax on that interest either.

A Matter of Fairness

But the tax exemption on muni-bond interest is worth the most to high-income taxpayers. That's because the amount you save on exempt muni-bond interest is directly tied to your tax bracket: The higher the bracket, the bigger your tax break.

Recent proposals would put a cap on the tax benefit you can gain from muni-bond interest, preventing high-income taxpayers from getting a full exclusion. That may seem fair, but it could also make life a lot harder for the governments that rely on muni bonds.

Paying More

Because of the tax exemption, muni issuers can offer lower rates than those paid by comparable taxable bonds. In a muni bond market estimated at $3.7 trillion, those lower rates save governments billions of dollars every year.

Tamper with the tax break, though, and you risk pushing muni rates higher. That will take away a big part of those savings and force states, cities and towns to bear an even heavier burden -- and to raise taxes to pay those higher interest rates. Given the financial stresses already hitting towns, that's the last thing many governments need.

Munis may help rich taxpayers, but they also help everyone by making public projects possible. Take the muni tax break away, and you risk plunging local governments into even more difficulty.


Motley Fool contributor Dan Caplinger owns some muni-bond funds. You can follow him on Twitter @DanCaplinger.

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Wayne

I doubt that we will see many of the tax breaks for the wealthy go away. Face it, they are the ones who buy the campaign TV adds that the 99% swallow hook line and sinker.

December 17 2012 at 6:22 AM Report abuse +7 rate up rate down Reply
teddy9463

i would love to see the 99% go on a rent strike all across the united states just for 2 months only, what would happen, evict everyone or sent everyone to jail, i doubt it

December 16 2012 at 8:27 PM Report abuse +7 rate up rate down Reply
teddy9463

You want to stick it to the rich real good, then don't spend money you do not have on useless gifts this year, by not spending any money their stocks portfolios will start to crumble hitting them right where it hurts, in their pockets, respect your hard earned cash folks because if you dont do that , you don't respect yourself.

December 16 2012 at 8:20 PM Report abuse +6 rate up rate down Reply
democrackso

EVANSADOPE

December 16 2012 at 5:49 PM Report abuse -4 rate up rate down Reply
3 replies to democrackso's comment
Jawmore

Tea party means actually Taxed. Enough. Allready. I suppose you lefty dims love taxes so you can't buy stuff.

December 16 2012 at 5:21 PM Report abuse +2 rate up rate down Reply
1 reply to Jawmore's comment
evan_barthold

When did O'Bama switch parties ?

December 16 2012 at 5:23 PM Report abuse -10 rate up rate down Reply
1 reply to evan_barthold's comment
evan_barthold

Barry loves exta money, espscially when it come to taxws,

December 16 2012 at 5:25 PM Report abuse -4 rate up rate down
Hello, Karen

The rich are going to whine and cry anyway.

December 16 2012 at 5:08 PM Report abuse rate up rate down Reply
2 replies to Hello, Karen's comment
evan_barthold

o'bama is rich

December 16 2012 at 5:10 PM Report abuse -3 rate up rate down Reply
Somey

Karen, isn't that the truth

December 16 2012 at 6:01 PM Report abuse +7 rate up rate down Reply
evan_barthold

I luv barrys nuts on my chin

December 16 2012 at 4:56 PM Report abuse -7 rate up rate down Reply
angelmomartin

Funny then how cities take our bonds for things such as sewer systems. Then they assess the taxpayers and say you can benefit by us taking out the bond, BUT we will charge you 2% monthly on the loan. Making a profit. Telling you that the city is using the funds for bookkeeping.
Odd thing is the county collects this, and cities stand to make a profit off of the loan to have no work.

As we can understand a one time set up fee but to make a profit from your residents is just wrong when residents have no choice, and cities should plan for future. Rather then spend it all concept they have today.

December 16 2012 at 11:28 AM Report abuse rate up rate down Reply
robmist

Ike was A republican and the country has not flourished like that since. Lets use the tax code he used and watch the rich cry and the country flourish. Trickle down economics is a proxy scheme and ilegal for any one except the government. The Bush tax cuts and his put every american in a home regardless if they can't pay for it led to the crash. Republicans need to pick someone with values to win. Worn out brainless actors and moran drunks won't cut it. America has started to wake up and even the Dems better wake up or you might all be looking for a job.

December 16 2012 at 5:06 AM Report abuse +2 rate up rate down Reply
1 reply to robmist's comment
mrspelosi

Robbie darling how sad for you that you wander through life in a state of confusion dear. It was us democrats who pushed for everyone to be able to own a home even if they could not afford it darling.
It is too bad that we have not found a democrat with values yet dear.

December 16 2012 at 10:01 AM Report abuse rate up rate down Reply
raydelv

Why didn’t this article appear during the campaign? This news agency is in the tank with the Democrats. I hope they stop the tax breaks, so that the liberal Cities can feel the pain of their own stupidity

December 15 2012 at 9:40 PM Report abuse +1 rate up rate down Reply