The vast majority of all American states exempt the gains their residents earn on in-state municipal bonds from personal state income tax while simultaneously taxing the gains their residents eam on out-of-state municipal bonds. States and municipalities have long issued bonds in order to “finance everything from bridge repair to school construction and water-system upgrades.” The current fiscal crisis afflicting the United States increases the likelihood that municipal bonds will become even more vital as states and cities seek solutions to their budget shortfalls. The importance of the tax exemption for municipal bonds is clear-without it, states and cities would be forced to raise the interest rates on their bonds in order to compete with private issuers in a time when competition with the private sector is already extremely difficult and states and cities are having trouble selling debt due to the credit crunch.

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