Definition
Municipal bonds (munis) finance public infrastructure and services. Their key advantage is federal tax exemption on interest income (and often state/local tax exemption for in-state residents). This makes their after-tax yield competitive with higher-yielding taxable bonds. General obligation (GO) bonds are backed by taxing authority; revenue bonds are backed by specific project income.
functions Formula
Tax-Equivalent Yield = Muni Yield / (1 − Tax Rate)
lightbulb Example
A muni bond yields 3.5% and the investor's tax rate is 37%. Tax-equivalent yield = 3.5% / (1-0.37) = 5.56%. A taxable bond must yield above 5.56% to beat this muni after taxes.
verified_user Key Points
- Interest typically exempt from federal tax
- In-state bonds often exempt from state/local tax too
- GO bonds backed by taxing power; revenue bonds by project income
- Higher tax bracket = greater benefit from tax exemption