The exclusion of state and local bond interest from Federal income tax often is criticized as creating a tax haven for the wealthy. Critics, however, often fail to take into account the effect of market forces. In recent months, the long-term tax-exempt interest rate has been 3.5%, while the long-term taxable rate for bonds of comparable risk was approximately 4.7%. On the other hand, state and local governments do enjoy a savings in interest costs because of the tax-favored status of their bonds.
To date, Congress has concluded that the benefits gained by the states and municipalities and their residents, such as the access to capital and the creation of jobs to construct and maintain critical infrastructure, outweigh any damages to our progressive income tax system. Do you agree with the proponents of the exclusion? Why or why not?