Supreme court maintains municipal bond tax breaks
The Supreme Court on Monday ruled that cities and states can keep offering special tax breaks on their municipal bonds, a decision that preserves a top incentive for investors in the $2.5 trillion municipal bond market.
The 7-2 high-court ruling reversed a Kentucky appeals court decision that said it was unconstitutional for the state to grant tax breaks on interest from bonds issued in Kentucky while taxing interest from bonds issued in other states.
The high-court decision was an important victory for municipal bond issuers in most states. Without the special tax breaks, municipal bond issuers would have to compensate investors with higher interest rates.
The decision overturned a Kentucky appeals court ruling that the state’s tax breaks violate the Commerce Clause of the U.S. Constitution, or an implied prohibition against states erecting trade barriers.
The ruling lifted a threat to an important segment of the mutual fund industry. The nearly 500 funds organized around bonds issued in a single-state would have had to disband or rearrange if the lower court ruling had been upheld. According to the Investment Company Institute, single-state funds had total assets of $155.83 billion in 2007.
“This removes a cloud of uncertainty that had been hanging over the market for at least six months cash advance usa. It will help heal the market,” said Bob Millikan, portfolio manager at BB&T Asset Management in Raleigh, North Carolina. “Many of the states that had been at risk of losing their specialty status will benefit. Their prices had been lower because of that risk.”
All told, 42 states follow Kentucky’s practice, and a Supreme Court ruling to uphold the lower court decision would have forced them to change their systems, with each state having to decide either to tax interest on in-state bonds or give breaks to out-of-state ones. Interest earned on municipal bonds is not subject to federal tax.
“We believe the court properly determined that municipal bonds are different with regard to the Commerce Clause,” said Tom Dresslar, spokesman for California Treasurer Bill Lockyer. “We’re not out to make a buck. When we issue these bonds it’s to provide a public service.”