Would Obama’s Proposal on Municipal Bonds Affect you?

February 20th, 2012 by

In his most recent budget, President Obama proposed limiting the tax benefits for interest earned on Municipal bonds. If the proposal was passed as is, married couples earning $250K ($200k for single returns) per year would have to pay a minimum federal tax rate of 28%. A tax filier meeting these income levels therefore could not use the Municipal bond interest tax exemption to get their tax rate below 28%.. (FYI, the deduction for charitable contributions and mortgage interest payments would also be subject to this rule.)

In the media, including on this site, there have been a number of articles saying the new change would have horrible implications:

1) This would be terrible for owners of municipal bonds, increasing their taxes.
2) This would be terrible for municipalities (cities, states, counties), increasing their borrowing costs and forcing them to potentially raise taxes or decrease services.

Cate Long, author of Muniland blog takes issue with both these contentions in her article titled 2.5 Million Muni Bond Investors Unaffected By Proposed Tax Changes

As the title indicates, out of the 3.5 Million holders of municipal bonds, only 920K would be impacted by this change. The proposal does not tax all Municipal bond holders, just the rich ones. I think Cate’s point is don’t assume this change is going affect your tax bill.

Will yields rise for municipal bonds? Cate thinks the impact will not be large. She points out that there is far more demand for municipal bonds than supply, and the majority of municipal bonds are in fact owned by people making less than 250K. While yields may increase some, the bigger change will be in the composition of those that hold the bonds; less rich people and more middle class people.

While I certainly don’t want to accuse Cate Long of being part of the Occupy Wall Street movement, I think her article could be re-titled “Obama’s Tax Proposal Favors the 66%.”

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