The Joint Committee on Taxation issued a report Friday that summarizes the federal code tax provisions that affect state and local governments, including those for tax-exempt, traditional tax-credit tax, and direct-pay bonds.
The committee released the
Generally the JCT report details the tax law provisions that govern tax-exempt governmental and private activity bonds as well as other types of bonds without espousing any opinions or conclusions, contrary to the Congressional Research Service's report on tax expenditures that the Senate Budget Committee recently released.
However, the JCT report contains a section on "Economic Issues of Tax-Exempt Bond and Tax-Credit Bond Financing" that states, "In addition to the deeper subsidy provided by the 100% tax-credit bonds, tax-credit bonds do not generate the same revenue loss inefficiency as do tax-exempt bonds."
"As explained ... in the case of a tax-exempt bond, the loss of federal receipts is greater than the reduction in the tax-exempt issuer's interest cost," the report says. "This is due to the existence of multiple tax brackets since the bond investor's tax saving is dependent upon [his, her, or its] marginal tax rate."
"With a tax-credit bond, the bond investor's tax saving is dependent of [his, her or its] marginal tax rate," the report says, adding, "As a consequence, with a tax-credit bond, the loss in federal receipts from the tax credit equals the reduction in the tax-credit bond issuer's interest cost."
In a section on investor benefits from bonds, JCT says: "Generally all other things being equal (such as credit worthiness), a bond investor is indifferent between a tax-exempt bond and a taxable bond with an equivalent after-tax yield."
On revenue losses to the federal government, JCT says, "The direct cost to the federal government of the interest exclusion for state and local bonds is the income tax revenue forgone."
JCT cites as an example, a bond investor with a 28% marginal tax rate purchasing a school district's $1 million tax-exempt bond with a 4.5% interest rate, saying the investor receives $45,000 of tax-exempt interest income for each year the bond is outstanding.
"However, assuming the bond investor's preferred alternative investment is a taxable bond, the actual revenue loss to the federal government is based upon the taxable yield the bond investor forgoes," the report says.
If the bond investor purchases a school district's taxable bond at a 6.25% rate, rather than the tax-exempt bond, the investor receives $62,500 in interest income and pays $17,500 in income tax. "In this case, the revenue forgone to the federal government equals the interest savings of the school district," the report says.
If the investor is in the 33% income tax bracket and purchases the school district's tax-exempt bond, it costs the federal government $20,625, or $62,500 of interest income taxed at a 33% rate, JCT says, adding, "Due to the existence of multiple tax brackets, the loss of federal receipts is greater than the reduction in the tax-exempt issuer's interest cost."
The report also discusses the federal income tax deduction for certain state and local taxes, noting this "creates a financial benefit that varies in magnitude for taxpayers across the income distribution and across geographic areas.
"Because the amount of the individual tax savings due to deductibility is directly related to the marginal rate of the taxpayer, itemizers with high incomes and therefore higher marginal tax rates receive higher benefits from deductibility than do lower-income itemizers with lower marginal tax rates," JCT says in the report. "Taxpayers who do not itemize receive no benefit."
"As a result, the deductibility of state and local tax payments decreases the progressivity of the federal income tax code," the report says. "Some critics of deductibility point to this features as undermining desirable policy goals of fairness in the code."
However, others point out that state and local governments with higher levels of public expenditures often have more progressive income distributions overall than those with relatively lower levels of public spending, the report notes.
The variation in geographic benefits results from the fact that taxpayers in wealthier states pay higher average state and local taxes due to higher income and property values, and benefit from higher average state and local tax deductions.
The states with the highest levels of average state and local tax deductions "are by far California, Connecticut, New Jersey, New York, Virginia and the District of Columbia, all areas with relatively high levels of income and high property values," the report states.
"Critics of deductibility point to this lack of horizontal equity across states as detracting from key policy goals of fairness," JCT says. "However proponents point out that state governments with high levels of deductibility also tend to spend more on local public services that may enhance goals of fairness, including those that subsidize low-income residents."
