The District currently provides an income tax break to D.C. residents who invest in bonds issued by other states and cities to support infrastructure improvements. This means that D.C. is rewarding residents who invest in other states’ infrastructure projects. Most states recognize that this is bad policy and that is why, outside of DC, only one state — Indiana —allows such a tax break.
Eliminating the tax break for out-of-state bonds makes sense for a number of reasons:
Most states provide an income-tax break only when residents invest in their own state’s bonds. This creates an incentive for residents to support their state’s infrastructure. Except for D.C. and Indiana, no state offers a tax break for residents to invest in out-of-state bonds, because they do not want to incentivize investment in other states’ infrastructure.
Bonds issued by cities and states are federally tax exempt, and this exemption is much more significant to investors than the D.C. benefit. More than three-fourths of the tax benefits D.C. residents get from investing in these bonds come from the federal tax exemption, because federal tax rates are higher than D.C.’s tax rates. The federal benefit would not change if the D.C. income tax exemption is eliminated.
Removing the tax exemption is a progressive tax change. Nearly three-fourths of the benefits from the current tax break goes to residents making $200,000 or more.
