Will Munis Lose Their Tax Exemption?

According to an article in today's Wall Street Journal, President Obama and Speaker Boehner are willing to consider deductibility limits on municipal bonds. Municipal bonds are bonds sold by state and local governments.  For many years, the interest earned on municipal bonds were exempt from federal income taxes. The idea was to reduce the costs of borrowing for state and local governemnts. Investors are willing to accept lower yields on municipal bonds because the interest is tax-exempt.  Investors care about their after-tax return, so an investor in the top tax bracket can recieve a lower interest rate on municipal bonds than on equivalent corporate bonds because of the tax difference.  One can argue that munipical bonds should or should not be treated differently. I suspect many people would like to see the interest on school bonds remain relatively low. But the rationale offered by politicians, according to the article, is interesting. Clearly, one goal is to increase federal government revenue. The article quotes a portion from the administration's budget documents arguing that limiting interest and other tax breaks for the higher-income households would, "reduce the benefit that high-income taxpayers receive...and help close teh gap between the value of these [breaks] for high-income Americans and the value for middle-class Americans."

I would have hoped there would have been some discussion about the impact on state and local governments and their ability to raise money for capital projects.  In general, I favor removing tax breaks across the board. Favoring some groups over others distorts capital markets. But if decisions are made based on income-redistribution concers only, then I don't see that as an improvement.