Zinkin: Taxing Municipal Bond Interest A Bad Idea

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There are things that are considered in Washington that have major impact on us as individuals.  One item being considered would have a significant impact on us, on the Town Of Oro Valley, and on every other city and town in the country.  The "idea" is to tax interest earned on municipal bonds. This is not a new idea. It has been "floating around" Washington for the past 10 years. It is another one of those ideas from the beltway folks about how to raise  revenues for their ever-increasing, voracious spending appetite.

In this case, it is simply a bad idea,  according to Oro Valley Council Member Mike Zinkin.   Speaking at last week's council meeting,  Zinkin observe that: "Congress, in trying to supplement the budget and reduce the deficit, is trying to pass a bill...to take away the tax free exemption on municipal bonds. They don't understand what that tax exemption does for every city and town.   It would cost local governments about $173 billion [annually] in [additional] interest expenses.  They don't understand that that is how we finance our swimming pools, our roads, our water...."

As Council Member Zinkin correctly observes, taxing municipal bond interest would substantially increase the borrowing cost of every municipality. Oro Valley would not be an exception.  Investors would require at least twice the interest rate for financing municipal bonds of smaller municipalities like Oro Valley than they currently require.   It may even be likely that small municipalities like Oro Valley would find it more difficult to place their bonds because their issuances are so small that  they are not of interest to the financing community.  Therefore, they may have to pay an even higher premium to issue their bonds.

The result is at least a doubling of interest expense for the town.  For example, a year ago the town issued approximately $2.495  million in revenue bonds for building the aquatic center.  The face interest rates on these bonds ranged from 2% to 4%, depending on the maturity date of these bonds.  The bonds mature in relatively even increments over 15 years.  These are tax exempt bonds.  Had these bonds than taxable, the interest rates would likely have been from 4% to 8%.

Total interest paid on these bonds will approach $1.2 million (estimate).   Had  the interest on these bonds been taxable,  the amount of interest would have doubled to $2.4 million.  It would likely have made the investment in the aquatic center infeasible; and that is after assuming that buyers could of been found for the bonds.

The only winner  if municipal bond interest becomes taxable is the federal government.  Every state and municipality would lose. They would lose because interest would cost them more. They would lose because they would likely have their ratings downgraded. They would lose because they may not be able to get financing since they would be competing with for-profit organizations.   Those of us who are investors would lose because, in the end, it would raise our taxable income levels both enabling the federal government to fund even more outrageous programs.
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