Obligations issued by state and local governments, where the interest income is not subject to federal income tax, offer a significant advantage to investors. These instruments provide a means for municipalities to fund public projects, such as infrastructure development, schools, and hospitals, while offering investors a tax-advantaged return. For example, an investor in a high tax bracket may find a tax-exempt bond yielding 4% equivalent to a taxable bond yielding 6% or higher, depending on the investor’s specific tax situation.
The primary benefit of these securities lies in their ability to shield investment income from taxation, thereby increasing the after-tax return for the investor. This feature makes them particularly attractive to individuals and institutions in higher tax brackets. Historically, the availability of these investment vehicles has been instrumental in facilitating essential public works projects, as the tax exemption lowers the borrowing costs for state and local governments.
