Reexamining the Tax Exemption of Municipal Bond Interest
Under the current U.S. tax code, individuals and corporations that own bonds are generally required to pay taxes on their interest income. However, since the enactment of the federal income tax in 1913, interest on state and local bonds has been tax-exempt. Over the next ten years, the federal government will forgo as much as $617 billion in revenue by excluding interest on state and local bonds from income taxation. As a result, the exclusion of municipal bond interest is one of the largest tax expenditures in the individual income tax code. This paper submits that lawmakers should seriously consider limiting, reforming, or eliminating the exclusion of municipal bond interest. While the federal government may have a legitimate role in subsidizing state and local government spending, the current exclusion of municipal bond interest has several flaws and drawbacks.