November 6, 2007
New York Sun on State Bonds Case
High Court May Protect States' Taxation of Bonds
by Joseph Goldstein, New York Sun
The Supreme Court appears hesitant to declare unconstitutional the widespread practice among states of giving tax breaks for in-state municipal bonds. New York is one of 38 states that tax the interest earned by out-of-state municipal bonds while exempting from taxation income earned from its own state or municipal bonds. Whether such an effort to raise funds for local public projects illegally interferes with interstate commerce is the central question of an appeal from Kentucky, which the federal high court heard yesterday. A decision by the court saying that the Constitution's commerce clause forbids states from enacting such tax discrepancies would shock the municipal bond market. Such a ruling could require states and municipalities to refund recent taxes collected from residents on interest earned on out-of-state bond investments. In New York alone, those claims could amount to $200 million, according to a brief filed by 49 states, including New York, in support of the Department of Revenue of Kentucky. What is unclear is how such a ruling would affect taxation of future bonds, as states would need to decide whether to either tax instate bonds or expand the tax breaks to also cover out-of-state bonds. While some states have a constitutional proscription against taxing interest from local bonds, New York does not. In New York, where city and state income taxes can top 10%, tax protections are especially crucial in making bonds attractive to local investors. On the other hand, a Supreme Court decision against the tax protections would mean "there are 280 million other Americans who would be more receptive to New York investments," an attorney at the Tax Foundation, Joseph Henchman, who assisted in drafting a court brief arguing against tax favoritism for in-state bonds, said.
