Published: May 20, 2008 02:35 pm            

Tax break upheld — 05/21/08

Law has benefited both local governments and investors

For almost a century, the tax breaks most states have given to the interest earned on municipal bonds have served well the interests of both local government and the holders of those bonds. In a 7-2 rulings in a case from Kentucky, the U.S. Supreme Court avoided creating chaos in the municipal bond market by upholding the tax breaks that have been in place for 90 years.

Kentucky taxpayers George and Catherine Davis of Jefferson County did not object to the tax break Kentucky law gives on municipal bonds issued in the state. Instead, they objected to having to pay state income tax on interest on municipal bonds issued in other states.

The Davises contended the Kentucky law violates the commerce clause of the U.S. Constitution giving Congress authority to regulate interstate commerce. But the tax exemption Kentucky offers on municipal bonds issued in Kentucky is also offered by 40 other states.

In their dissent, Justices Anthony Kennedy and Samuel Alito said the majority decision “invites other protectionist laws.” However, writing for the majority, Justice David Suiter said the state tax exemptions have not hindered commerce among the states. If the exemption has not led to other protectionist laws or limited competition in nearly a century, there is no reason to expect them to do so in the future.

“It would miss the mark” to think that the courts “are being invited merely to tinker with details of a tax scheme,” wrote Souter. “We are being asked to apply a federal rule to throw out the system of financing municipal improvements throughout most of the United States.”

If the ruling had gone the other way, the 41 states that offer the tax breaks could have been faced with refunding taxes going back several years. New York State said such refunds could total $200 million, plus $70 million a year in lost revenue.

The tax exemptions make municipal bonds more appealing to investors. The tax exemptions can offset the lower interest rates offered on the bonds. And the lower interest rates means local governments are able to borrow more money.

Municipal bonds finance the purchase of public lands as well as the construction and improvement of public buildings, transportation systems and water and sewer facilities. Those are good things that benefit entire communities. In its ruling Monday, the highest court in the land simply maintained the status quo that has been in place for nine decades.

        

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