Obama proposes municipal bond tax exemption cap, again

WASHINGTON, April 10 Wed Apr 10, 2013 8:01am EDT

WASHINGTON, April 10 (Reuters) - U.S. President Barack Obama in his budget on Wednesday proposed capping the value of the tax exemption for interest paid by municipal bonds, suggesting once again a way to raise revenues that has rattled the $3.7 trillion municipal bond market for more than a year.

According to a summary released by the White House, in his budget proposal for fiscal 2014 Obama would limit the value of tax benefits for the top 2 percent of earners to 28 percent from the current 35 percent.

If approved, the cap would essentially drive down the appeal of municipal bonds often sold to wealthy investors who can exempt the interest from their federal income taxes. It risks pushing up the borrowing costs for state and local governments that use the bonds to finance bridges, roads and other capital projects.

Obama was expected to release his full budget later Wednesday morning.

The budget is a proposal and, as has happened in past years, will likely not become law. Moreover, members of both parties in the U.S. Congress have expressed opposition to limiting the municipal bond exemption, including heavy hitters such as Republican House Majority Leader Eric Cantor and Democratic Massachusetts Senator Elizabeth Warren.

This is the third time Obama has suggested capping the value of the tax exemption for high-income earners - he did so in the 2013 budget and also in his American Jobs Act in 2011. The independent, bipartisan tax reform group known as Bowles-Simpson also suggested limiting the tax break.

Specifically, he has suggested making the bonds subject to a 28-percent cap for individuals earning more than $200,000 or couples more than $250,000.

In fiscal year 2011, the U.S. government missed out on collecting $30 billion in revenues because of the exemption, according to the Congressional Budget Office. The exemption dates back to the federal tax code's creation in 1913.

In February, U.S. Treasury Secretary Jack Lew said during his nomination hearings that the suggestion had been intended as "a fall-back, saying that if tax reform doesn't happen, this is something that would help us to get to the revenue targets we need."

Still, governors, mayors, state lawmakers, and investors are on guard against the cap now more than ever.

As the federal government scrambled to avoid the "fiscal cliff" of sequestration and tax increases at the end of 2012, some lawmakers brought up the limit as a way of raising revenues. Some feared it would be eliminated altogether.

Recently, a coalition of city and county leaders estimated they would have had to pay $18.8 billion more in interest over the last decade under Obama's cap and $53.8 billion if the exemption were removed.

For example, Virginia's Fairfax County paid $98.1 million in interest on its debt last year. It would have paid $14.6 million more under the cap and $41.8 million if the exemption were eliminated, according to the coalition, which included the U.S. Conference of Mayors and the National Association of Counties.