The most recent Presidential proposal to raise tax revenue once again targets the two percent. But does it? The proposal would cap the tax exemption at 28%; for those in higher brackets income derived from municipal bonds would be taxed for the percent their tax bracket is above that waterline. For example, consider someone who earns $200,000 in municipal bond interest and is in the 39.6% tax bracket who currently owes no federal tax for the income earned. If this proposal should pass the taxpayer would now owe $23,200 in taxes.
The result indeed could be higher taxes paid by this taxpayer. However, consider how this taxpayer might alter his or her investment strategy or behavior. The investor would demand higher interest payments, because the taxable equivalent yield would be substantially reduced. The investor might shift to investments that offer tax-deferred status or equities for long-term capital gains where they control if and when there is a taxable event.
Higher interest payments to attract investors would hit the bottom line of this country’s municipalities and make it more difficult to raise funds for projects. If municipalities have to pay higher debt service there is less funding available for schools, infrastructure projects, police officers, and firemen. Tax-exempt municipal bonds fund the vast majority of all US public infrastructure projects. By limiting the tax-exempt status you limit these projects and cut the budgets of all state and local governments.
As financial advisors we would undoubtedly consider altering our investment strategies to reduce the tax burden for our clients and we will continue to monitor the situation.
All comments and questions welcome.
Suzanne M. Antonelli, CFP®