DC’s Millionaire Tax Shelter: Out-of-State Bonds

May 6th, 2013 | by Ed Lazere

Who is affected by DC’s current policy of phasing out the tax break for out-of-state bonds? That question is central to an ongoing debate about the future of this tax break, which Mayor Gray has proposed to restore. 

Newly available data provide stark evidence that tax-exempt bonds serve primarily as a tax shelter for very high-income DC residents, many of whom earn millions each year from these tax-free investments. However, the data also show that a small number of residents, with much more modest incomes, rely on municipal bonds as a major source of income. This suggests that it makes sense for the District to continue phasing out the out-of-state bond tax break — one that no other jurisdiction offers — while taking steps to make sure that low- and moderate-income families are protected. 

Here is what the new figures, from DC’s Office of Tax and Revenue, show:  Over three-fourths of tax-exempt interest income earned by DC residents goes to households who have income of $200,000 or more beyondwhat they earn from tax-exempt bonds. Indeed, 81 DC households earned an average of $2 million from tax-exempt interest in 2010, and these 81 households accounted for 43 percent of all tax-exempt interest earned in the city.  

At the same time, there are 338 households that have income below $50,000 and get more than one-third of their income from tax-exempt interest. These are likely to be the households that policymakers have in mind when they talk about restoring the out-of-state bonds tax break. 

Together, this suggests that DC’s current policy — which maintains a tax exemption for all investments in out-of-state bonds made prior to 2013 and eliminates the tax break for new investments— should be continued. It would raise roughly $1.7 million in revenue in 2014 and ultimately about $30 million per year. The current law maintains a tax break for investments in DC-issued bonds, which creates an incentive to buy these bonds, which, in turn, makes it easier and cheaper for the city to issue bonds. 

What about low- and moderate-income residents who rely on out-of-state bonds? The grandfathering of current tax exemptions provides time for these households to plan and adjust. Some will start investing in DC bonds, and others will seek other investment options, such as highly rated corporate bonds that yield similar after-tax returns. To further protect these residents, the District could allow households below a certain income level — such as $75,000 or $100,000 — to retain the tax break fully. 

A concern about protecting retirees who rely on out-of-state bonds makes sense. But, using that argument to protect a tax shelter for multi-millionaires does not.

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One Response to “DC’s Millionaire Tax Shelter: Out-of-State Bonds”

  1. Beth Marcus says:

    It is very sad when the discourse turns from differences in perspective to the sensationalism of this blog. The blog contains misleading or misrepresented facts, incorrect statements, and the omission of facts that are part of what appears to be a campaign led by DCFPI against a grassroots effort consisting mostly of senior citizens. Just some examples:
    • The article heading is incredibly misleading. Yes there are 81 filers with million dollar plus tax exempt income. At the same time, there are 17,967 filers who did not have this income.
    • Mr. Lazere would have a special, unique tax on those with incomes above $75,000 or $100,000 – incomes significantly lower than the $350,000 income level used for the higher income marginal tax rate. Thus, a new definition of high income would be created and this definition would only apply to one thing: municipal bond income. Only bondholders would be treated as if they are now in a high income bracket even though their income would be as low as 21% of what is considered a higher income for tax rates.
    o This would be the only tax in the country that taxes based not only on incomes but where the payer (like a bank paying interest is a payer, a bond issuer is also a payer) is located. No matter what your income is, there is no tax on DC bonds. It is only if you combine income with where the bond issuer is located when there is a tax.
    • Bondholders are significantly seniors and retirees – probably somewhere between 50% and 75% of the total number of filers (as estimated by the AARP) but certainly more than 26% that Mr. Lazere used in his May 3, 2013 testimony to the Council. But even if we use the very understated figure of 26%, with only 11.3% of DC’s population as seniors (compared to 13% nationally) this is still disproportionately high. Municipal bonds are an investment tool for retirees. It’s that simple.
    • The CFO 4 year total revenue projection from the bond tax is $11 million and this is just an estimate based on debatable assumptions. The revenue projection of $30 million per year which Jenny Reed of DCFPI told me is expected in 12 to 15 years is as reliable as projecting where the stock market will be in 12 to 15 years. In addition, from 2008 to 2010 bondholding filers declined 9% without even having a bond tax. Further, people with higher incomes are migrating to Maryland and Virginia. Lastly, with so many seniors as bondholders, many if not most will not be in DC in 12 to 15 years.
    • Mr. Lazere is not telling the truth when he says that all other jurisdictions tax out-of-state bond incomes:
    o There are 9 states that do not tax some or all out-of-state income (7 with no state income tax plus North Dakota and Utah.) In the case of Utah, if a state doesn’t tax Utah bonds then Utah won’t tax that states’ bonds. Without a bond tax, DC bonds would have a market (Utah) with a population that is 4.5 times DC’s population.
    o Washington is a city, not a state. Just compared to our neighbors, DC is 68 square miles while Maryland and Virginia are, respectively, 12,407 and 42,769 square miles. If you live in Baltimore which has a similar population size to DC, you can buy bonds issued anywhere in the state. In the entire US, there is no city or county whose residents pay tax on all municipal bonds issued outside its borders. If the bond tax remains in place, DC will be the only city with such a tax.
    • A study on the Tax Review Commission where Mr. Lazere is a member shows that the growth in the DC population is from people with lower incomes moving in while higher income residents are moving to Maryland and Virginia, thus resulting in lost revenue from the higher income earners who paid DC income tax, sales tax, real estate tax, etc. For a bondholder, if there is a bond tax, there are over a 100 reasons to move to either Maryland or Virginia based on available bond choices: for Maryland, 97 bonds issued in 2012, 45 state only bond funds, and 1 state only bond money market account; and for Virginia, 136 bonds issued in 2012, 44 state only bond funds, and 5 state only bond money market accounts. Contrast this with DC with only 15 bonds issued in 2012 and no bond funds or money market accounts.

    The bond tax will not raise the revenue Mr. Lazere suggests. What it will do is hurt a lot of retirees who have worked and lived in Washington for all or much of their lives, contributing to the community, paying income, sales and real estate taxes, and who just hope they can stay and continue contributing without being singled out with a tax that disproportionately hurts seniors and that takes away the same kinds and numbers of investment choices available to their Maryland and Virginia neighbors. We are treated like second class citizens by others too much already; do we have to be the ones who turn ourselves into second class citizens too?