A draft federal tax reform proposal unveiled on Capitol Hill last week includes new taxes on municipal bond interest collected by wealthy individuals. If approved, the plan would likely raise borrowing costs for communities and water utilities that issue municipal bonds to fund infrastructure improvements.
The new taxes on municipal bond and other interest income are part of a long awaited proposal from House Ways and Means Committee Chairman Dave Camp (R-Mich.) to streamline the tax code by lowering corporate and personal income tax rates and eliminating dozens of deductions and exemptions. Major components of the plan would establish two main personal income tax brackets at 10 and 25 percent and would reduce the corporate tax rate from 35 to 25 percent. Camp would pay for these changes by eliminating or capping several popular deductions for all taxpayers (such as those for state and local taxes and home mortgage interest), as well as creating a new top tax bracket with further limits on deductions and exemptions for individuals and families with high incomes.
Taxpayers in the new top bracket would pay a 10 percent surtax on portions of income above $450,000 for joint filers (or $400,000 for singles) that would otherwise be exempt from taxation – including interest earned on municipal bonds. In addition to municipal bond interest, taxpayers in the new top bracket would 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.
While the municipal bond interest exemption would remain in place for taxpayers below the top bracket, the change would still carry repercussions for the municipal bond market. An analysis conducted last year by AMWA and the National Association of Clean Water Agencies found a similar proposal – to limit exemptions by joint filers earning more than $250,000 – would have reduced the value of outstanding municipal bonds, thus causing investors to unload them in the secondary market and pushing interest rates higher. Had this policy been in place in 2012, the analysis found, communities across the U.S. would have paid an additional $6 billion in water infrastructure debt service costs.
The exact cost of the Camp proposal to local communities is not yet known but would likely be significant given that high-income taxpayers typically invest in municipal bonds at a higher rate than other individuals.
AMWA is coordinating with a number of other organizations to push back against any new taxes on municipal bond interest. However, the prevailing sense on Capitol Hill is that Rep. Camp’s proposal has virtually no chance of advancing through Congress this year. Instead, it is being viewed as a first step toward a larger debate over appropriate revisions to the tax code. At AMWA’s Water Policy Conference in April, Rep. Randy Hultgren (R-Ill.) of the House Financial Services Committee will discuss the prospects for the municipal bond interest exemption.