State and Local Governments

The direct cost to the federal government of this interest exclusion is the individual and corporate income tax revenue forgone. Consider the aforementioned case where a 35% marginal tax rate corporate investor who purchases a 6.5% tax-exempt bond with principal of $1,000 that is to be repaid after 20 years. Each year for 20 years this taxpayer receives $65 in tax-exempt interest income. Each year the federal government forgoes collecting $35 of revenue because the revenue loss is based upon the yield the taxpayer forgoes. For example, if the investor had purchased a taxable bond carrying a 10% interest rate, he would have received $100 in interest income and paid $35 in income taxes on that income.

The annual federal revenue loss (or tax expenditure) on the outstanding stock of tax-exempt bonds issued for public purposes is reported in the Analytical Perspectives section of the Budget every year. The estimates since 1994 are displayed in Table 1. Because they are based upon the outstanding stock of public-purpose tax-exempt bonds, it takes time for some legislative changes to show up in these data. The amount of forgone tax revenue from the exclusion of interest income on public-purpose tax-exempt bonds is substantial; $20.5 billion in 2016. Over the 2017 to 2026 budget window, the estimated loss of revenue is expected to be $422.8 billion, or the 15th - largest tax expenditure.

Table 1. Tax Expenditure on the Outstanding Stock of Public Purpose Tax-Exempt Bonds: 1994 to 2017 (in billions)