Supreme Court may take municipal bond tax case

The U.S. Supreme Court may take up a case that challenges states’ rights to exempt their own bonds from local taxation if they tax the interest paid on other states’ bonds.

The case could have widespread ramifications for states and municipal bond investors if the high court were to decide that the current tax structure was unconstitutional.

The justices have been asked to rule on a Kentucky court’s decision that the state’s practice of exempting local bonds from Kentucky income tax while taxing out-of-state bonds was unconstitutional because it discriminated against interstate commerce.

More than 40 states, including California, have similar dual-tax policies that effectively give an advantage to their own municipal securities.

The Supreme Court may decide as early as next week whether to hear the case. A panel at a meeting last week of the Municipal Analysts Group of New York said they expected the court to take up the case -- and to overturn the Kentucky court’s ruling.

“The court will not throw a monkey wrench into municipal bond financing,” said Greg Germain, an assistant professor in the Department of Law at Syracuse University in New York and one of the panelists.

Walter Hellerstein, professor of taxation law at the University of Georgia and another of the panelists, said the court may uphold so-called dual taxation just as state universities are allowed to charge higher tuition to out-of-state students. States are allowed greater leeway to discriminate when they are acting as a market participant rather than a regulator, he said.

Should the high court decide that it was unconstitutional for states to tax out-of-state bonds and not their own, states would have to choose between taxing or exempting all municipal bonds, regardless of their state of origin, panelists said.

Either way, if there is no in-state tax advantage, some states might have to pay higher rates on their own securities to lure investors.

But even if the Supreme Court upheld the Kentucky court decision, analysts said they expected that high-tax states and municipal bond market participants would lobby Congress for a federal law that explicitly allowed the dual-tax practice.