Calvin H. Johnson is a professor of law at the University of Texas. Prof. Johnson wishes to thank Profs. Daniel Halperin, Victor Thuronyi, Alice Abreu, and Larry Zelenak for helpful comments on an earlier draft. The commenters are not responsible for the final conclusions reached here.

This proposal would repeal section 103, which now exempts interest paid on state and local bonds. The exemption wastes most of its federal cost. The fraction of the cost delivered to borrowers induces them to undertake projects that would not be rational given the real cost of capital. The exemption would be replaced with a budgeted payment to current borrowers to reduce their debt. Current bonds would be taxable prospectively but with a credit for discount or implicit tax that was of help to the borrower.

The proposal is made as a part of the Shelf Project, a collaboration among tax professionals to develop and perfect proposals to help Congress when it needs to raise revenue. Shelf Project proposals are intended to raise revenue, defend the tax base, follow the money, and improve the rationality and efficiency of the tax system. The tax community can propose, follow, or edit proposals at http://www.taxshelf.org. A longer description of the Shelf Project is found at "The Shelf Project: Revenue-Raising Proposals That Defend the Tax Base," Tax Notes, Dec. 10, 2007, p. 1077, Doc 2007-22632 [PDF], or 2007 TNT 238-37 .

Shelf Project proposals follow the format of a congressional tax committee report in explaining current law, what is wrong with it, and how to fix it.

Repeal Tax Exemption for Municipal Bonds