This article was originally published in Bloomberg Brief Municipal Market 7/22.
The tax-exempt market “raises equity questions,’’ Senator Ron Wyden, D-Oregon and chairman of the Senate Finance Committee, told reporter Brian Chappatta last week during a Q&A session at Bloomberg headquarters.
He expanded, “I have accountants come and tell me ‘here’s all the people that we do taxes for, and all their income is municipal bonds. Do you think they shouldn’t pay anything to be part of making sure that there are services in this country that we all use?’ ’
’The syntax was a bit garbled. I think I get the message, though. This is why we should do away with the tax-exemption on municipal bonds. When I read this, I thought, Oh, no! Mrs. Dodge is back!
Can you imagine? Anna Thompson Dodge was the widow of automotive pioneer Horace Dodge. When he died in 1920, the money she inherited was put into muni bonds. As the New York Times reported in its 1970 obituary, Mrs. Dodge never had to pay federal income tax.
Mrs. Dodge has been haunting the municipal market, well, probably since Mr. Dodge died in 1920. Her good fortune fueled the rage and envy of all those who see tax-exemption as the exclusive preserve of the rich. As, literally, the nation’s No.1 tax dodge.
Let’s take a look at the numbers. According to the Winter 2014 edition of the IRS’s Statistics of Income Bulletin, 5,951,659 returns claimed tax-exempt interest amounting to $65 billion in 2012. That’s out of almost 145 million returns filed (almost 28 million claimed dividends).
A closer look at the tax-exemption is afforded in the IRS’s study of “High-Income Tax Returns for 2011,’’ contained in the Spring 2014 bulletin. A pie-chart there carrying the weighty title “Returns with No Worldwide Income Tax and with Expanded Income of $200,000 or More: Primary Reason for No Income Tax Liabilities, Tax Year 2011,’’ shows that there were 15,000 tax returns like this. “Tax-exempt interest was the primary reason for nontaxability on more than half (58.2 percent) of these returns,’’ the article states.
Which means, I think, that 8,730 households have put all their money into tax-exempt municipal bonds, and live off the income. The IRS doesn’t say when these filers put all their money into taxexempts, or how long they have done so.
And of course, we are talking here about something that is completely legal. So on the one hand, we have 8,730 tax filers who have put all their money into taxexempt bonds, and who seem to be getting the full (and for some, feared, maybe even wicked) benefit of the tax-exemption. That’s only one part of the story.
There’s another part. The other beneficiaries of the tax-exemption are the 90,056 governmental entities who can borrow at tax-exempt interest rates.
Then of course there are what we might call the ultimate beneficiaries of the taxexemption, all 317 million of us who use the schools, roads, bridges and such financed in the municipal market.
How does the math work, exactly? In order to tax the 8,730 filers who shelter all of their income through the purchase of tax-exempt bonds, let’s wreck the municipal bond market, which has worked pretty well for 101 years and which now benefits 317 million people. I don’t think the numbers add up.
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