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Joint Committee on Taxation staff drafts plan that would tax interest on municipal bonds

From the October 19, 2012 issue of Public Power Daily

Originally published October 19, 2012

By Jeannine Anderson

Interest on newly issued state and local bonds would be taxed under a tax reform scenario crafted by Thomas Barthold, chief of staff for the U.S. Congress's Joint Committee on Taxation.

Barthold described the plan, which he called "an experiment," in an Oct. 11 letter to the leaders of the Senate Finance Committee. The chief of staff said he had begun work on the plan, but fleshed it out after  Finance Committee Chairman Max Baucus, D-Mont., asked about the idea of ending all income tax deductions, credits, and exclusions—including the exemption for municipal bonds—to offset revenue lost from reducing federal income tax rates.

In addition to taxing interest on state and local bonds issued after Dec. 31, 2012, Barthold's "experiment" would repeal all itemized deductions that now are allowed on federal tax returns, including the deduction for homeowners' mortgages. The proposal also would raise revenue by taxing capital gains and dividends as regular income, not at reduced rates.

In his letter to Baucus and to Sen. Orrin Hatch, R-Utah, ranking Republican on the Finance Committee, Barthold said that ending the itemized deductions and the exemption on municipal bond interest would save enough money to cut federal income tax rates by 4 percent.

The proposal assumes that the 2001 and 2003 tax act provisions would expire and that current-law statutory rates and policies would take effect as planned on Jan. 1, 2013.  Specifically, it assumes that on Jan. 1, 2013, federal income tax rate brackets will increase to 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent. Under the Joint Committee on Taxation scenario, those rates would be cut to 14.4 percent, 26.88 percent, 29.76 percent, 34.56 percent and 38.02 percent.

The exclusion for state and local bond interest would be the only above-the-line deduction repealed.

The Barthold experiment includes a number of revenue-losing provisions: it would repeal the individual alternative minimum tax and would repeal the overall limitation on itemized deductions and personal exemptions for high-income earners.

The plan was immediately criticized by Hatch and by David Camp, R-Mich., chairman of the House Ways and Means Committee, but neither of the lawmakers mentioned the provision that would end the exemption on municipal bonds.

Instead, press releases issued by Ways and Means and Hatch's office objected to the proposal's assumption that the 2001 and 2003 tax cut provisions enacted under President Bush will expire, rather than assuming that those tax cuts will be extended.

Hatch and Camp also objected to the plan’s proposal to tax capital gains and dividends as regular income, rather than at reduced rates.

The Joint Committee on Taxation "experiment" has not been backed by any elected official – at least not publicly. It is significant, though, because it shows that the tax-exempt status of state and local bonds is considered a feasible target for repeal.


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