Obama targets muni bond tax exemption for those who earn more than $200K

President Barack Obama's plan to cut the budget deficit repeats his call for curbing the tax exemption on municipal bonds and would give states a break on unemployment debts owed the federal government. The recommendation includes tax overhauls proposed this month that would limit exemptions for interest on state and local government bonds for those who earn $200,000 or more annually. To offset the expected rise in muni borrowing costs, Mr. Obama last week proposed giving states that have run out of money for unemployment benefits two more years of interest-free loans. The ideas are part of a package that he submitted to a congressional panel seeking to cut $1.5 trillion from the deficit over the next decade. By pressing for tax increases, mostly aimed at the wealthy, Mr. Obama places himself at odds with Republican leaders who want to focus on scaling back spending. Any push to reduce the tax exemption on muni bond interest also may face resistance from local government officials coping with fiscal pressure from the recession and a loss of federal stimulus money. California Treasurer Bill Lockyer said recently that losing part of the tax break might cost his state as much as $7.7 billion. Because the interest earnings on government bonds are exempt from taxation, investors have been willing to accept lower returns, driving down the cost of public projects. About $32 billion, or 47%, of the tax-exempt interest claimed in 2009 was paid to those who earn more than $200,000 annually, according to the Internal Revenue Service.

REINING IN DEFICIT

The tax break has withstood challenges in Congress amid a push to rein in the federal deficit. A presidential commission recommended scrapping it last year as part of an overhaul of the U.S. tax code, while Sen. Ron Wyden, D-Ore., proposed replacing the exemption with a credit. Neither plan advanced. The Obama administration has proposed aiding state and local governments by providing $35 billion to prevent public employee layoffs, a plan that was reiterated last week. In addition, Mr. Obama proposed providing assistance to states that have run out of money to pay for unemployment benefits because of persistently high joblessness. More than half of U.S. states have borrowed from the federal government to pay claims and now collectively owe more than $37 billion, according to the Labor Department. The plan offered by Mr. Obama calls for forgiving interest payments on the debt for two years, along with forgoing the automatic tax increases that businesses in indebted states face. To shore up the trust funds later, it would increase wages subject to federal unemployment tax to $15,000, from $7,000.