HOSTILE ARGUMENT: THE FAIRTAX WILL HURT STATE AND LOCAL GOVERNMENTS THAT ISSUE BONDS
This week, we take on an argument that you may not have heardabout the FAIRtax. A member of my town council voiced concern that under the FAIRtax, towns, counties, and states would have a more challenging time borrowing money. Under today's federal tax code, state and local governments can issueincome-tax-free bonds to their lenders.
The tax free status of those bonds makes them attractive investments, even at lower interest rates. In today’s world, corporate bondholders have to pay income tax on the interest they receive from those bonds. In turn, corporations have to pay higher interest rates on their bonds to make them competitive with the tax free bonds.
My town council member was concerned that the FAIRtax would erase the tax advantage that government bonds currently enjoy over corporate bonds. With government and corporate bonds competing for investors’ money on an even playing field, he was afraid that the FAIRtax would make it more expensive for state and local governments to borrow money.
But there is a flip side to my town council member’s argument. Under today’s tax code, only high-income lenders would find state and local tax-free bonds attractive. The FAIRtax would open the state and local government market to a whole new class of investors. This new class of investors would increase the supply of funds from which state and local governments can borrow, thereby driving down the cost of borrowing.
Perhaps there is a non-tax reason why state and localgovernment bonds would still be attractive relative to corporate bonds - safety. Governments are less likely to default because they can compel their taxpayers to cover the debt in a way that corporations cannot.
Upon its implementation, the FAIRtax may give a windfall to those who just bought corporate bonds as the tax liability goes away while the higher interest rates stay. Corporations may call those bonds. However, over time, the differences will even outand the FAIRtax will have accomplished one of its major design goals—be fair to everyone by treating everyone the same.
I would love to hear your thoughts about corporate and municipal bonds under the FAIRtax. How can we squeeze this explanation into a soundbite?
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