The Importance of Tax Exemption for Municipal Bonds

 The Importance of Tax Exemption for Municipal Bonds

A traditional feature of many municipal bonds is their tax-exempt status. For investors who purchase certain municipal bonds, the interest received can be exempt from state and/or federal income tax. For this reason, investors who receive tax-exempt interest are generally willing to accept a lower interest rate than they would if they did not receive tax-exempt interest.

Tax Exemption Benefits Municipalities, Investors and the Public

The benefit for municipalities is access to lower interest cost funding options. For a given revenue stream (e.g. annual property taxes), the municipality could access more proceeds due to the lower borrowing costs. Conversely, for a given project amount, the municipality could require a lower revenue stream, again due to the lower borrowing costs.

The benefit for the public is potentially more infrastructure/equipment such as new schools and technology, at lower costs.

Many homebuyers consider their local school districts when deciding where to purchase a home. A home in an award winning school district’s boundaries may command a higher price than a comparable home down the street in a less regarded school district’s boundaries. Real estate agents and real estate developers often tout a reputable local school district in marketing materials.

In a perfect world, well-appointed school facilities enhance learning, attract more staff members, and encourage students to attend class. This could result in higher academic, co-curricular or extracurricular achievements. These achievements could win recognitions and build a reputation for the school district that attracts homebuyers and increases home values. From this viewpoint, property taxes paid to enhance school facilities may add desirability and/or value to home prices. In other words, the taxes could pay for themselves.

Tax Exemption is Synonymous with Municipal Bonds

Every so often, legislation is considered to remove the tax-exempt feature from municipal bonds. I believe this could negatively impact the funding of future public facilities. Losing tax exemption could make financing more expensive because taxable interest rates are generally higher than tax-exempt interest rates. Tax exemption is synonymous with municipal bonds. The investors in tax-exempt municipal bonds are a large investor base comprised of mom and pop retail, mutual funds, money managers, banks, insurance companies, and other institutions. Losing this investor base/demand might even result in higher interest costs than the tax-exempt vs. taxable interest rate spread would suggest.

Tax exemption is an important aspect of municipal bonds that benefits municipalities, investors and the public.

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