By Jonnelle Marte
The perks of municipal bond investing are on the chopping block — again.
President Obama has proposed limiting the amount of interest from municipal bonds that high earners can exclude from their taxable income, a move that could make the bonds much less appealing for their biggest buyers.
As of now, muni bond income is tax-exempt. For couples earning more than $250,000 per year, the president is proposing to reduce the tax break on muni bond income to 28%, from a current maximum of 35%. For people in the 33% and 35% tax brackets, that amounts to a tax on muni bond income between 5% and 7%.
This isn’t the first time the tax-exempt status of muni bonds has been threatened. As recently as last year, lawmakers debated altering the tax exemption last year as part of the tax reform legislation, to no avail. The proposal is once again likely to face strong opposition from state and local governments. Investors are normally willing to accept lower yields on municipal bonds because the income is tax-free, which is a savings for the state or local issuer. Without the tax benefit, municipal governments argue, they would have to pay higher yields, which would increase their cost of borrowing and funding municipal projects. (To calculate the benefits of tax-free bond income, Morgan Stanley offers this tax-equivalent yield calculator.)