When States Discriminate: The Non-uniform Tax Treatment of Municipal Bond Interest


Dwight Denison is an associate professor of public and nonprofit finance in the Martin School of Public Policy and Administration at the University of Kentucky. His areas of teaching and research include municipal bond markets, nonprofit financial management, and tax administration. E-mail:dwight.denison@uky.edu

Merl M. Hackbart is a professor of finance and public administration and associate dean for administration and academic affairs in the Gatton College of Business and Economics at the University of Kentucky. E-mail:m.hackbart@uky.edu

Michael J. Moody is an assistant professor in the Department of Public Administration at the University of Kansas. His research interests include public debt policy and management and tax policy. E-mail:mjmoody@ku.edu


There is a long history of states using tax systems to encourage residents to invest in bonds issued by jurisdictions within their state. This preferential or discriminatory tax treatment was ruled unconstitutional in 2006 by the Kentucky Court of Appeals. The Kentucky court decision, which sets the stage for this essay, was overturned by the U.S. Supreme Court in 2008. This essay addresses the possible implications of this and similar discriminatory tax policies. Such discriminatory policies are the foundation of the municipal bond market, and altering the practice would have significant implications for revenue collections and borrowing costs in most states and localities. While the Supreme Court's position has been rendered, the case has caused policy makers and administrators to scrutinize discriminatory tax policies and their impact on budgets and borrowing costs.