AUSTIN, TEXAS (April 3, 2025) — As Congress debates major changes to federal tax policy, a new report from the Lyndon B. Johnson School of Public Affairs at The University of Texas at Austin, in partnership with the University of Chicago’s Harris School of Public Policy, has released a timely and accessible guide to one of the most important — and often misunderstood — tools for funding infrastructure: the federal tax exemption on municipal bond interest.
The report, “Municipal Bond Tax Exemption: History, Justifications, Criticisms, and Consideration of Reforms,” serves as a resource for policymakers seeking to understand the historical context, economic rationale, and potential policy considerations surrounding municipal bond tax exemption.
The policy report is intended to provide a clear and objective foundation for policymakers as they assess potential changes to the tax treatment of municipal bonds. It does not advocate for any specific course of action but instead compiles the best available evidence on the topic to ensure that decision-makers have access to reliable information as they deliberate.
“From sewers to schools to hospitals, municipal bonds are how communities finance critical infrastructure,” said Martin Luby, director of the LBJ School’s Center on Municipal Capital Markets. “This report gives policymakers the context they need to evaluate reform proposals and understand what’s really at stake — especially for smaller governments that depend on this financing tool.”
The policy report presents several key findings, including:
- Municipal Bonds and Infrastructure: U.S. infrastructure is funded through federal, state, and local sources, with municipal bonds playing a key role, backed by federal tax exemptions.
- Market Size: $4.2 trillion in outstanding municipal bonds (~$20,000 per household), financing roads, schools, hospitals, airports, and more.
- Cost Savings for State and Local Government: Federal tax exemption saved state/local governments $714B (2000-2014) and is projected to save $824B in the next decade.
- Additional Costs to Federal Government: Exemption cost the federal government ~$52B in 2024, raising concerns about efficiency, equity, and transparency.
- Small vs. Large Issuers: Most issuers are small and rely on tax exemption; removing it could limit infrastructure investment. Large issuers dominate the market and capping tax-exempt debt could shift costs to smaller entities.
- Other Policy Implications: Eliminating the exemption without alternative subsidies would shift financial responsibility to state/local governments, effectively creating an unfunded mandate with uneven regional impacts.
The report examines several reform proposals under discussion in Congress, including limits on how much tax-exempt debt governments can issue, ending the exemption for certain types of bonds, or targeting reforms toward large, frequent issuers. While states and large cities might adapt, the report warns that such changes could increase borrowing costs or reduce access to capital for smaller, less frequent issuers — reducing investment in critical infrastructure.
It also addresses the future of Private Activity Bonds (PABs), which fund projects that offer both private and public benefits, such as affordable housing, student loans, and public-private partnerships. Critics say PABs subsidize private enterprise, but the report notes their importance for underserved communities and their role in financing essential infrastructure projects.
As members of Congress weigh the implications of modifying or retaining the municipal bond tax exemption, this policy brief provides a factual basis for understanding the trade-offs associated with different policy approaches. The research underscores that while the exemption has played a pivotal role in infrastructure finance, any changes should be considered in light of their broader economic and fiscal impacts.
Read the full report.
About The LBJ School’s Center On Municipal Capital Markets
The Center on Municipal Capital Markets (CMCM) at the Lyndon B. Johnson School of Public Affairs at The University of Texas at Austin focuses on advancing expertise in municipal capital markets. With growing infrastructure needs, CMCM provides specialized education and training for students, government finance professionals, and the public. Through graduate programs, research, and outreach, the center enhances knowledge in municipal finance and supports both emerging and experienced professionals. For more: https://lbj.utexas.edu/cmcm
About The Lyndon B. Johnson School of Public Affairs at The University of Texas at Austin
The LBJ School of Public Affairs at the University of Texas at Austin is one of the nation’s premier public policy schools, uniquely positioned within a top-tier research university, the State Capitol and one of the America’s most innovative cities. Founded in 1970 by President Lyndon B. Johnson to expand access to the halls of power, the school offers a range of nationally ranked degree programs that prepare students to take on society’s most pressing challenges. The LBJ School also provides career development and leadership training to emerging policy leaders and operates numerous research centers that develop solutions to complex local, state, national and global challenges.
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