WASHINGTON (Reuters) - President Barack Obama on Monday proposed limiting tax breaks given to high-income earners on the interest paid by municipal bonds, a change that could rock the $3.7 trillion market if approved.
In his fiscal 2013 budget, Obama reiterated his desire to cut tax breaks for families with incomes over $250,000, saying they should only be allowed to reduce their tax liabilities by 28 percent from the current 35 percent.
Among the list of breaks, Obama included tax-exempt interest, the payments made by U.S. municipal bonds.
Individual investors who buy municipal bonds frequently have high incomes, and one of the debt's chief selling points is that they can deduct the interest from their federal income taxes.
The long-standing practice allows states, local governments and authorities to offer lower interest rates on tax-exempt debt than they would on taxable bonds.
The budget, which must wend its way through a politically fractured Congress, also proposed "an expanded and permanent extension" of the Build America Bonds program created in the 2009 economic stimulus plan.
Alongside the proposal, it advocated allowing a wider universe of bonds, including Build America Bonds (BABs), to be refunded.
"State and local bond programs have varied in the extent to which they expressly allow or treat refinancings," according to budget documents. Granting "a general authorization for refundings of state and local bonds not currently covered by specific refunding authority would promote greater uniformity, tax certainty, and borrowing cost savings."
Under Obama's plan, issuers would only have two restrictions on refunding bonds. They could not issue refinancing bonds with greater principal amounts than the original bonds, and the new bonds could not have average maturities greater than the debt being refunded.
This will be the third year in a row Obama has tried to make the taxable BABs program, which expired in December 2010, permanent.
Republicans and Tea Party conservatives criticized the program, which paid issuers a federal rebate equal to 35 percent of interest costs, as rewarding profligate states while funneling taxpayer dollars to Wall Street underwriters. Over the last year, hopes for a revival of the program have all but died.
Obama proposed operating the BABs program for two years with a subsidy of 30 percent and then "extend it permanently thereafter at a subsidy rate of 28 percent."
Cities, states, schools and other issuers sold $181.5 billion of BABs from April 2009 through the end of December 2010, according to Thomson Reuters data.
(Reporting By Lisa Lambert; Editing by Andrea Ricci and Jeffrey Benkoe)