One of the ways that the very wealthy avoid taxes is by receiving their income from tax free investments such as Treasuries. Treasuries yield much less than other investments in ordinary times, and the nation as a whole benefits from low interest rates on US debt, so it seems fair.
But what about Munis (municipal bonds)? Lowering those interest rates benefit only a locality, while often the state or even the federal government is implicitly backstopping them, reducing the risk to the bond purchaser. Why should they enjoy a federal tax break?
Capping Muni tax exemptions is one of the reforms being discussed in Washington. Patti Domm, CNBC:
While Congress isn’t yet expected to try to change muni bonds’ tax-free status, industry experts think lawmakers could take a first step by limiting how much income investors could deduct under the popular tax break, which has been around since 1913.
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Alexandra Lebenthal, CEO of Lebenthal and Co, said … a possible outcome is that individuals will be restricted on how much muni income they can deduct.“Basically, you would be limited in terms of the deductions you can take and in terms of your tax exempt income to at least that earlier 28 percent bracket. In the past you could have obviously had so much tax exempt income that you were in no tax bracket or in a lower tax bracket than 28. That’s what people should be thinking about now is that 28,” said Lebenthal.
The argument will be made that rebuilding after hurricane Sandy will require Muni issuance and so Congress will cave in to lobbyists doing special pleading for municipal bonds on the grounds that they need to rebuild. I think what this really means is that we ought to recognize that the federal role in insuring against disasters needs to be elevated and we should stop pretending that states can handle the large financial demands levied by a disaster of the magnitude of Katrina or Sandy.