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Obama plan on tax-exemption limit faces uphill battle

Sep 13, 2011, 1:04 p.m.
President Barack Obama speaks to faculty and students after touring a newly modernized graphic design classroom at Fort Hayes Arts and Academic High School in Columbus, Ohio, September 13, 2011. REUTERS/Larry Downing

Most general obligation debt is issued for infrastructure projects. Obama's plan relies on heavy spending on school construction and road repair to fulfill his promise of creating jobs. In effect, the law would exchange locally driven financing arrangements for direct funding, Bird said.

"You could be essentially starving Peter while paying Paul," Bird said.

Politically, fights over the federal deficit have put the exemption on interest under fire. Members of the Obama administration and Congress are discussing alternatives such direct-rebate debt, in which the U.S. government would rebate to issuers part of their interest payments on taxable bonds, and tax-credit bonds, which give buyers credits on their taxes.

In December, Obama's deficit commission suggested ending the exemptions for all municipal bonds sold in the future. The Congressional Budget Office, a nonpartisan government research agency, has said the federal government forgoes more than $25 billion annually from the tax breaks.

The fact that Obama's curb on deductions would include eligible mortgage expenses, state income and local property taxes and charitable donations, along with interest on municipal bonds, should produce a groundswell of opposition to the move by affected groups, according to John Miller, co-head of global fixed income at Nuveen Asset Management.

Miller said it was unlikely the provision will become law, adding that its passage would trigger lawsuits challenging the retroactive application of the new deduction cap on existing municipal bonds. Also, the measure could launch another legal fight over states' rights similar to the one being fought by some states over the federal health care reform act, he added.

(Reporting by Karen Pierog, additional reporting by Chip Barnett in New York and Lisa Lambert in Washington; Editing by Dan Grebler)

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