Congressional Republicans are floating a proposal to overturn a century-old income tax exemption on municipal bonds, a crucial financial tool cities like Madison use to fund infrastructure, buildings and affordable housing.
Removing the exemption would significantly impede city construction efforts and increase burdens on state and local taxpayers, says Kurt Paulsen, UW-Madison professor of urban planning: “The taxpayers are going to pay more, either directly through increased borrowing costs or indirectly through reduced infrastructure quality.”
That tax increase, according to a study by the Public Finance Network, a coalition of state, local and municipal bond issuer organizations that are lobbying against the repeal, could be as high as $6,500 per household over the next decade.
Barriers to construction could impede Madison’s push to build new housing at a time when city leaders say they cannot build fast enough. Madison has the highest annual rent increase (14.1%) in the nation and one of its lowest rental vacancy rates (2.8%). The city aims to create 15,000 new homes by 2030 and have one-quarter of those homes be affordable for those making 60% of the area’s median income.
“You either stop building affordable housing projects because they don’t pencil out, or you have to increase subsidies from some other source. Or you would have to increase the rent to cover that increased debt,” Paulsen says.
A municipal bond is a debt security issued by a governmental entity. Despite the name, it’s not just municipalities issuing them: state governments or affiliates, like the Wisconsin Housing and Economic Development Authority, also issue bonds, says Paulsen. They’re typically used to finance capital projects: long-term investments such as buildings, streets and bridges.
After purchasing a bond from the government, the bondholder receives semi-annual interest payments and the principal once the bond reaches maturity. For the city of Madison, bonds usually mature 10 years after purchase, says Finance Director David Schmiedicke.
Bonds typically pay on a regular schedule, providing investors a predictable income stream that is less volatile than stock holdings. Individual investors constituted around 45% of municipal bond holders in the third-quarter of fiscal year 2024, trailed by mutual funds, banks, insurance companies, and other classifications of investors, according to data from the Securities Industry and Financial Markets Association.
Federal law has, since the passage of the Revenue Act of 1913, exempted interest repayments on municipal bonds from investors’ federal income taxes. But in a leaked 51-page document from the U.S. House Ways and Means Committee, Republican lawmakers proposed ending that exemption in order to reach Trump’s $4.5 trillion in tax cuts over the next 10 years. The committee estimates the move would net the government $250 billion in tax income over the same period.
Were the exclusion repealed, the incentive for supporting municipal projects would be diminished and governments’ interest rates would increase.
“[Right now, governments are] borrowing, in essence, at a below-market interest rate, because people who buy the bonds are exempt from federal income taxes,” Paulsen says.
Most of the city’s capital projects are financed through bonds, Schmiedicke says, and the city plans to issue approximately $130 million in tax-exempt debt annually over the next six years. He says a repeal would mean “there’d be a higher cost to the city for each dollar spent on capital projects.”
“Obviously that translates into possibly higher taxes for residents,” Schmiedicke says. Residents would either have to pay more to maintain the city’s current building efforts, or the city would have to reduce investments in such things as street reconstruction, equipment purchases and public buildings, he adds.
Paulsen notes that taxpayers would eventually pick up the bill for delayed repairs. “Maybe your road gets repaved every 30 years, instead of every 20 years, which means you’re going to pay in additional costs for wheel alignment and suspension.”
Overall construction for public entities across Wisconsin would likely slow if borrowing costs increase, Paulsen says, and sticker prices on funding capital referendums would be substantially higher.
But affordable housing projects, in particular, are at risk under the proposed repeal, Paulsen says: “A lot of affordable housing projects are seven to 12 different funding sources and are really right at the line of being financially feasible. If you now add on hundreds of thousands of dollars of increased debt costs, these projects are no longer feasible, or they would require additional subsidies, which comes from government tax money.”
It’s unclear whether the proposal will be included in the proposed budget. At least one Republican on the Ways and Means Committee, U.S. Rep. Rudy Yakym of Indiana, opposes the cut, according to reporting from Bloomberg.
“As we look at the menu of options that are available to us, my goal in the committee is to ensure that municipal tax-bond exemption removal is not on that menu for discussion,” Yakym told the publication.
Democratic U.S. Rep. Gwen Moore of Wisconsin, who is also on the Ways and Means Committee, tells Isthmus in a statement that she opposes the proposal and that just the threat of removing the exemption “can chill investments in [state and local] communities.”
“The fact that the Republicans are even considering removing this federal tax exemption should be concerning for all,” Moore adds.
In a Jan. 31 welcome letter to the 119th Congress outlining reasons to “protect and bolster the tax-exempt municipal bond market,” the Public Finance Network noted that infrastructure funded by the municipal bond market “makes possible nearly every aspect of daily life and is critical in building and maintaining a strong economy for every citizen and business in the country.”
The 37 officers who signed the letter, representing various industry and government associations, noted that state and local governments fund around 90% of public-sector construction, mostly through municipal bonds. Beyond large infrastructure projects, the majority are “routine, but critical investments made by small towns and rural communities.”
And, the letter notes, municipal bonds provide a dependable fixed-income financial investment to senior citizens: “With a default rate of less than 0.1%, nearly 60% of tax-exempt bond interest earned by individuals goes to those age 65 and older.”
Paulsen notes that the repeal could face bipartisan pushback.
“It’s not just blue states that finance roads and schools with municipal bonds, it’s red states as well,” Paulsen says. “I would imagine you’ll be hearing from red state governors and mayors pretty strongly.”
He likens the current budget process to “a giant freight train moving through Congress.”
“Everybody’s trying to pile on their own special projects on board,” Paulsen says. “So who knows what’s actually going to happen?”
