President Obama’s $447 billion job-creation plan includes a proposal to remove the tax break on interest earned from municipal bonds for top earners. Currently this income is exempt from federal taxable income. The plan would require couples earning more than $250,000 a year, or $200,000 for single taxpayers, to pay 28% tax on interest earned from municipal bonds.
The municipal bond market is estimated at $2.9 trillion. This proposal will surely reduce the demand for state and local-government securities. Obviously, this would face resistance from state and local-governments. Furthermore, states, cities and counties have yet to recover from effect of the recent recession and are likely to need additional sources of funds. This proposal could put further strain on already fragile state and local-governments by forcing them to pay higher interest rates in order to offset the lost tax break and attract sufficient capital.