The future status of tax-exempt municipal bond interest was called into question this month when federal policymakers unveiled a pair of proposals that would force high-income taxpayers to pay some taxes on their municipal bond income.
The proposals, from House Ways and Means Committee Chairman Dave Camp (R-Mich.) and President Obama, respectively, would each phase-out a number of tax benefits for the nation’s highest-earning individuals and families – including the exemption of municipal bond interest from federal income tax. Each plan would continue to allow lower and middle-income taxpayers to collect municipal bond interest tax-free.
Chairman Camp’s muni bond proposal is part of a much larger tax reform plan he unveiled on Capitol Hill at the end of February. The plan would lower corporate and personal income tax rates, but would pay for these lower rates in part by scaling back or eliminating dozens of existing deductions and exemptions.
Under the Camp plan, individual taxpayers with an income above $400,000 (or families earning above $450,000) would pay a new 10 percent surtax on portions of their income above that amount – including municipal bond interest income that would otherwise be exempt from all federal taxation. To illustrate, a family that collects $450,000 in regular taxable income and $50,000 in municipal bond interest would pay a 10 percent tax on the municipal bond interest, in addition to their regular income taxes. But a family with $200,000 in regular taxable income and $200,000 in municipal bond interest would continue to pay no tax on the muni bond income, because their overall earnings fall below the $450,000 threshold.
Aside from municipal bond interest, wealthy taxpayers would also pay the 10 percent surtax on most itemized deductions, foreign earned income, employer-provided health insurance premiums, 401(k) contributions, and untaxed social security benefits.
Similarly, the FY15 budget request released by President Obama this month would “limit the tax rate at which high income taxpayers can reduce their tax liability to a maximum of 28 percent.” The limit would phase out the ability of high earners to claim a number of itemized deductions and other tax benefits, including tax-free interest earned on municipal bonds. This marks the third straight budget in which Obama has asked Congress to cap tax deductions and exemptions for high-income families, but lawmakers have ignored his previous requests in this area.
Neither the Camp plan or President Obama’s request are expected to gain traction on Capitol Hill this year, but they could lay the groundwork for future tax law changes. AMWA is therefore working to educate lawmakers about how rolling back municipal bond tax benefits would lead investors to demand higher interest rates from communities – thus increasing local financing costs on water infrastructure and other capital investments.
Last year, an analysis conducted by AMWA and the National Association of Clean Water Agencies (NACWA) found that limiting municipal bond tax breaks for joint filers earning more than $250,000 would have cost communities across the country an additional $6 billion in water infrastructure debt service costs in 2012 alone.
AMWA members traveling to Washington next month for the association’s 2014 Water Policy Conference will be encouraged to visit their congressional representatives to advocate for maintaining tax-exempt municipal bonds. Rep. Randy Hultgren (R-Ill.), a member of the House Financial Services Committee and a defender of municipal bonds, is scheduled to speak about the topic during the conference.