HOSTILE ARGUMENT: THE FAIRTAX WILL HURT TOWNS THAT BORROW AT LOW RATES TODAY
City Hall
We continue a series of articles about handling attacks on the FAIRtax. Today’s argument is one you won’t hear often, but I heard it from a member of my town council who was also a Senior Vice President at Merrill Lynch. Let’s call him Frank. Frank noted that our town now borrows money at low interest rates because state and municipal bonds are free from federal income tax. People who buy these bonds are willing to accept lower interest rates because the interest is tax-free to the bondholder.
Frank was concerned that, under the FAIRtax, people would no longer buy state and municipal bonds because there would no longer be any tax advantage to them. Our town would no longer be able to borrow at preferred rates, and higher borrowing costs would force our town council to raise taxes or reduce services.
Frank’s concern was genuine. For our town, the municipal debt is about the size of the annual budget. And debt service, i.e., the annual cost of paying down principal and paying interest on the debt, is the third-largest line item in the budget.
Fortunately for the FAIRtax, there is another side to Frank’s argument. Today’s cohort of municipal bond purchasers is limited because only taxpayers in high tax brackets can justify accepting the lower interest rates that municipal bonds offer. Under the FAIRtax, all bond rates, including corporate bond rates, fall because the tax component of interest income is eliminated.
The market for municipal bonds would open up to taxpayers who would reject them today because of their lower yields. With more people in the municipal bond market under the FAIRtax, the supply of funds available for municipal borrowing grows while the demand for municipal borrowing remains constant. The increase in supply holds down interest rates and puts the town in about the same place it is today in terms of borrowing.
You probably won’t get this question, but if you do, I would love to hear from you.
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TAKE BACK CONTROL!