President Obama and congressional Republicans haven’t seen eye to eye lately, especially when it comes to taxes, but the Wall Street Journal reports that they may have found one issue on which they agree: eliminating the tax exemption for municipal bond investments. There looks to be at least a chance that eliminating or significant reducing these breaks will become a significant part of any possible deal to keep from going over the fiscal cliff.
Both sides can find something to like in getting rid of this exemption. Obama and the Democrats like it because it raises taxes on income that goes predominantly to the rich. Boehner and the Republicans like it because it allows government to raise revenue without raising tax rates. And the potential budget savings are significant: lost revenue from this exemption is estimated at $30 billion per year.
There’s one group that doesn’t like this emerging bipartisan compromise, of course: city mayors. They worry that their cities’ borrowing costs are about to rise:
By exempting municipal bond interest from federal taxes, the government creates an incentive for investors to buy them, which helps hold down the borrowing costs of the states, cities and other entities that issue them. Curbing the exemption would likely reduce demand for the bonds, pushing those borrowing costs higher.
State and local governments, dealers in the $3.7 trillion municipal-bond market, and other interest groups have mounted a lobbying effort to keep the tax out of any agreement forged by the White House and Congress to avoid the fiscal cliff.
Investors are willing to accept lower yields for municipal bonds because their interest income is exempt from federal income taxes and from taxes in the state in which the bonds were issued. In some high-tax areas, such as California, the bonds are also exempt from local income taxes.
What this means is that the exorbitant costs of blue governance in urban districts with crippling regulatory burdens, out of control public unions, and other factors are spread around to taxpayers in general. The municipal bond interest exemption is a federal subsidy for blue—like the federal tax exemption for state and local tax payments, it is a complicated mechanism that reduces the burden of blue governance primarily on the rich.