U.S. Supreme Court likely to hear muni tax case: panel

By Anastasija Johnson

NEW YORK (Reuters) - The U.S. Supreme Court is likely to announce on Tuesday that it will hear a Kentucky case that could change how states tax bonds in the $2.3 trillion municipal market, an industry panel said on Friday.

Kentucky has asked the Supreme Court to review a state appellate court decision that taxing in-state bonds differently than those issued by other states is unconstitutional.

The Supreme Court held their private conference on Friday to consider various cases, including the Kentucky one. The orders disclosing the results from the conference will be released on Tuesday.

Walter Hellerstein, a professor of taxation law at the University of Georgia, said there was a "high probability" that the Supreme Court will hear the case.

Speaking at a luncheon in New York, Hellerstein said the case meets all the criteria to get the high court's attention.

"Ohio says 'x', Kentucky says 'y,' and in our system only the Supreme Court can resolve this," Hellerstein said. "They take that duty very seriously."

While an appellate Kentucky court decided that the state cannot tax interest on out-of-state bonds while exempting its own, an Ohio court had previously ruled the opposite.

The case also has broad national significance and some Supreme Court judges are interested in revisiting the constitutional interstate commerce clause that is evoked in this case, he added.

Market participants are closely watching the case because prices and demand for municipal bonds depend on how states tax in-state and out-of-state securities.

The case is also important for muni mutual funds with $364.9 billion of net assets outstanding, according to Investment Company Institute data from December.

The case also has implications for states, particularly large issuers such as California and New York, because no tax on in-state bonds creates demand and slashes the states' borrowing costs. According to Bear, Stearns & Co., 37 states tax interest earned on bonds issued out of state.

Greg Germain, assistant professor at the Syracuse University College of Law, also believes the court will hear the case, he said it is likely to uphold the Kentucky appellate court decision.

"If they rule that Kentucky violated the commerce clause by exempting in-state bonds and not-exempting out of state bonds, that would apply to every state and they would all be in violation of the Constitution," Germain said.

That means that states will have to decide whether to tax interest on all bonds or exempt all bonds.

If they decide the former, it will become more expensive for some to borrow money for infrastructure and other needs in the municipal bond market.