Federal Taxation of Municipal Debt

Summary

This practice note discusses federal taxation of municipal debt. The most common way for localities to supply needed capital facilities, such as buildings, roads, libraries, and other facilities is to finance them. While the government bodies could attempt to finance their needed facilities by competing with nongovernmental borrowers, most choose to avail themselves of a special governmental advantage by issuing bonds whose interest payments are exempt from federal income tax. The federal tax exemption feature has a major impact on local governments in that it reduces the cost of obtaining funds for capital projects.