"State and local governments would likely be better off in the long-term with lower, simpler tax rates on citizens and businesses than with higher rates and a federal tax subsidy for their debt," Sen. Tom Coburn said in his "Tax Decoder" report.

WASHINGTON — Congress should eliminate the tax exemption for municipal bonds, Sen. Tom Coburn said in a report released on Tuesday.

"There is little economic reason to encourage state and local governments to issue debt rather than spend their money in other ways," the Republican from Oklahoma said in his "Tax Decoder" report. "Further, state and local governments would likely be better off in the long-term with lower, simpler tax rates on citizens and businesses than with higher rates and a federal tax subsidy for their debt."

Coburn is retiring from the Senate at the end of this Congress. During a press conference, he said his goal with the report was to explain what provisions in the federal tax code do and what their effects are. He noted that members of Congress frequently talk about wanting to change the tax code, but don't talk about what specifically in the code needs to be changed.

"Tax-exempt interest for municipal bonds functions largely as a subsidy for state and local debt, and results in a big tax break for the wealthy, at a cost of more than $40 billion every year," Coburn said in a statement sent to The Bond Buyer. "Like many other provisions outlined in Tax Decoder, it is another inefficient tax break that meddles in the market and results in higher debt and taxes for the general public."

The report says the muni exemption is inefficient because the tax savings for investors from it tend to be significantly higher than the interest savings for state and local governments. An Internal Revenue Service report found that most tax filers who earned at least $200,000 in 2009 and didn't pay any federal taxes called tax-exempt interest the most important reason why they didn't pay taxes, Coburn said in his report.  The exemption also can "put upward pressure on borrowing costs," because it gives an incentive for state and local governments to issue more bonds, Coburn's report said.

The Simpson-Bowles commission in 2010 recommended eliminating the exemption for new bonds, and Congress should follow the commission's lead, the report said. The Joint Committee on Taxation and the Congressional Budget Office have discussed replacing the exemption with a credit. Doing so could eliminate "the extra subsidy for the wealthy," the report said.

Coburn also criticized specific types of tax-exempt and tax-advantaged bonds in the report.

Governmental bonds have been used to finance projects such as sports stadiums, hotels and golf courses. These types of projects can't be financed by tax-exempt private-activity bonds, so some state and local governments go to great lengths to prevent their bonds from meeting the private-activity bond tests, the report said.

"While Congress should not attempt to exhaustively list every type of facility that should be barred from receiving governmental bonds, at a minimum, non-essential, lucrative endeavors such as golf courses, professional athletic stadiums, and luxury hotels should be explicitly prohibited from receiving tax-exempt financing," the report said.

Also criticized are industrial development bonds, which Coburn said in the report "have benefited companies with little need of federal support."

Some exempt-facility bonds have been used in questionable ways, Coburn said. For example, sewage facilities that only benefit private manufacturing facilities can be financed with the bonds. Also, exempt-facility bonds issued to finance public school facilities can be used to finance school athletic facilities. Additionally, some qualified zone academy bonds, which are tax-credit bonds, have been used for projects that are not academically oriented.

The mortgage revenue bond and multifamily housing bond programs are expensive and overlap with other federal programs that have the same goals. There is also little evidence that MRBs have helped to raise the homeownership rate, the report said.

Nonprofits that benefit from 501(c)(3) bond proceeds have to use their scarce resources to make sure that their  bond-financed facilities comply with federal tax requirements. Similarly, businesses in impoverished areas using empowerment zone bonds have to maintain compliance with burdensome requirements for those bonds, the report said.

The report also criticized included student-loan bonds and tribal economic development bonds.

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