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Could Municipal Bonds Lose Their Tax-Exempt Status?

Will municipal bonds lose their tax exempt status? That’s the proposal found on page 211 of a 264 page report titled “Budget Options, Volume 2,” that the Congressional Budget Office released on Aug. 6. The CBO proposes eliminating the tax-exempt status of state and local government bonds in favor of tax credits.

The move would bring an estimated $19.8 billion into government coffers from 2010-2019, but investors in the top tax bracket would probably pay more than they currently save by buying munis. At least that appears gist of this phrase: “…switching to the credit would prevent bondholders from receiving gains that exceed the investment returns necessary to induce them to buy the bonds.”

The proposal was, however, just one of 66 made in the second volume of the report and the Bond Buyer reported that muni market pros didn’t expect the proposal to become reality. “…the potential revenue gains are relatively small compared to other options and might not be worth the backlash,” it quoted experts as saying.

Here’s the question: Would you continue to invest in munis if their tax exempt status was replaced with a tax credit?

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