Supremes weigh muni-bond taxation

The U.S. Supreme Court will hear arguments today in a case that could affect the way states tax other states’ bonds. Traditionally, state governments have provided investors an incentive to keep their capital within state lines: Interest on gains from the state’s own bonds was exempted from state income tax, while interest from other states’ bonds was usually taxable. However, a state court of appeals ruling in Davis v. Kentucky Department of Revenue found that it was unconstitutional for states to favor their bonds by providing a tax advantage. This preferential tax treatment violates the Commerce Clause, which says that Congress has the authority to legislate trade between states, according to court documents. Should the Supreme Court side with the finding and eliminate the status quo in-state tax treatment, state municipal bond yields would go up in high-tax areas, such as New York and California. Yields would fall in places like Alaska and Wyoming, according to “Davis v. Department of Revenue of Kentucky: A Preliminary Impact Assessment,” a paper by Dwight Denison, professor of public and nonprofit finance at the University of Kentucky. The paper, written for the Institute for Federalism and Intergovernmental Relations, was coauthored by Merl Hackbart, professor of finance and public administration at the University of Kentucky, and Michael Moody, an assistant professor in the department of public administration at the University of Kansas.