...Taylor hints at a good policy compromise, which will never see the light of day — ending the tax preference for municipal bonds. The interest received by holders of municipal bonds is “triple-tax-exempt” to holders of those bonds from those municipalities. Thus, if the city of Rochester borrows money to renovate a bridge, and it pays interest on those bonds, the interest income to me is exempt from any local taxes, any state taxes and any federal income taxes so long as I am a resident of Rochester. In other words, it is cheaper for the city of Rochester, ceteris paribus, to borrow funds than it is for corporations and even the federal government (remember, that is a ceteris paribus observation). Thus, municipal bond tax policy is regressive for TWO reasons: at the individual level and at the state level. At the individual level, the typical holders of municipal bonds are high net worth individuals who like the secure stream of tax free income (of course there are institutional investors who hold them on behalf of less wealthy clients). This income is not taxable to these high net worth individuals. Since the muni market is pretty illiquid, and typically requires large blocks of funds to engage in, the little guys are largely excluded from taking part in that market. Plus, the tax free income is “worth more” to someone in a higher marginal tax bracket than in a lower one. Muni bonds are regressive in a less obvious way too. How? Well, since the interest is exempt from federal income taxes, in effect when states and cities borrow money they are receiving subsidies from the federal government to do it. The states that are on net the largest borrowers tend to be the richer states and “spendier” states. Therefore, taxpayers in Kentucky, Alabama, West Virginia, Mississippi, and other lower income states are subsidizing spending on (sometimes questionable) projects in wealthier states. Now, in the US, the “South” is not very important, so I suppose this sort of a thing is celebrated in a weird kind of Neitzschean sort of a way.
Put these together and if you eliminated the tax preference for municipal borrowing you would probably generate more federal tax revenues, make the federal tax system more progressive and encourage municipalities to be more prudent in terms of what they borrow money for: when they have to pay 7% interest on debt and not 5%, for example, my sense is that they are going to work harder to get their public pension and health benefit plans under control. Of course, if it ever came to that, I am almost sure that we’d see an increase in these sorts of activities: but that is a post for another day.
]http://theunbrokenwindow.com/2012/03/16/politics-isnt-about-policy-episode-3758897/ |
