For the fifth year in a row, President Obama’s budget proposes limiting the ability of high-income taxpayers to exclude municipal bond interest from income – a provision that if enacted would likely drive up borrowing costs for local water utilities.
Currently, certain types of income – including interest earned on municipal bonds, retirement contributions, and employer sponsored healthcare costs – are exempt from the federal income tax. But a package of revenue proposals released by the Treasury Department on February 9 in conjunction with the President’s FY17 budget “would reduce the value to 28 percent of the specified exclusions and deductions that would otherwise reduce taxable income in the 33-percent, 35-percent, or 39.6-percent tax brackets.” The change is part of a proposal to “Reduce the Value of Certain Tax Expenditures” that begins on page 164 of the electronic pdf file (though the page is numbered 153).
To demonstrate, under current law all income earned generated by municipal bond interest is free from federal tax, so an individual in the 39.6 percent tax bracket effectively saves 39.6 cents in taxes for every dollar of municipal bond interest earned in that bracket. But under the White House proposal the marginal tax reduction would be capped at 28 cents per dollar – making municipal bonds a less attractive investment for those in the three highest tax brackets.
AMWA and other municipal organizations have previously argued that adding new taxes to municipal bond interest would lead wealthy investors to demand higher interest rates on the bonds, and thus force communities to pay higher financing costs when issuing bonds for water infrastructure improvements.
Congress has never acted on President Obama’s previous calls to tax municipal bond interest, but the idea has been discussed on Capitol Hill in the context of comprehensive tax reform. Lawmakers are not expected to attempt to undertake a major tax overhaul before 2017, so in the meantime AMWA will continue advocating against any plan that would raise borrowing costs for local communities and water systems.