President Obama’s FY14 budget proposal includes language to cap tax deductions for high-earning families – a provision that could drive up municipal bond borrowing costs for local governments.
According to a budget summary released by the White House earlier this month, the plan would limit “tax deductions and other tax benefits for the top 2% of families to 28%” of total income. Among the impacted tax benefits would be the interest earned by buyers of municipal bonds, which is now exempt from federal income taxes.
The current tax-exempt status of municipal bond interest leads investors to accept lower interest rates from borrowers, thus allowing communities to stretch their dollars further when selling bonds to finance water system and other infrastructure improvements. But President Obama’s proposal would likely cause these costs to rise, as muni bond interest that exceeds 28 percent of income for wealthy investors would be fully taxed. As a result, these investors would demand higher interest rates from communities to make up the difference.
President Obama previously recommended capping the value of tax exemptions for high-income earners in his FY13 budget and also in his American Jobs Act of 2011, but Congress never advanced either proposal.