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PROPOSAL TO ELIMINATE THE TAX-EXEMPT INTEREST ON MUNICIPAL BONDS IS A BAD IDEA

Kenneth Woods
Apr 23
2 min read

A renewed push to eliminate the federal tax exemption for municipal bond interest has surfaced in Congress. House Budget Committee Republicans have proposed ending the exemption as a potential source of significant revenue to help address rising federal deficits. However, policy experts caution that such a move could have costly consequences for state and local governments, potentially increasing their borrowing costs by more than $800 billion and putting critical infrastructure projects and public services at risk.

Repealing the exemption without a federal replacement subsidy or transition support would severely constrain infrastructure investment at the state and local levels. Governments would face stark choices: raise local taxes, cut essential services, or delay much-needed upgrades. State and local governments are responsible for roughly 80% of infrastructure spending nationwide, including roads, bridges, and water systems, excluding projects funded by federal dollars.

Historically, tax-exempt municipal bonds have been a cornerstone of infrastructure financing. Without the tax benefit, investors would demand higher yields, making it more expensive for municipalities to issue debt. This could lead to scaled-back or postponed investments in schools, hospitals, and transportation networks.

According to a report from the Harris School of Public Policy at the University of Chicago, this will disproportionately hurt smaller issuers which would require a complete, fundamental revamping of their debt management, as on average, 52%(1) of the issuers in a Congressional district are below the $30 million threshold. In six Congressional districts more than 90% of issuers are below that threshold. Lawmakers should consider these smaller municipalities would face significant challenges in adapting to a taxable bond market, including higher transaction costs and difficulty attracting investor interest.

In effect, ending or reducing the municipal bond tax exemption functions as a hidden tax increase on state and local governments, one that would be borne disproportionately by communities with fewer resources.

(1) Intercontinental Exchange (ICE) data, as of January 15, 2025

APA-2504-47