Washington focuses on muni market: much legislative, regulatory, and judicial attention has been focused on the problems municipal bond issuers are facing as a result of disruption in the capital markets.

• Author: Gaffney, Susan
• Position: Federal Focus

Congress, the Securities Exchange Commission (SEC), and other regulatory bodies, as well as the U.S. Supreme Court, have been actively addressing issues that are important to municipal bond issuers. While most of the activity has been in reaction to the problems municipal bond issuers are facing as a result of disruption in the capital markets, the Supreme Court's decision for the Commonwealth of Kentucky in Davis v. Kentucky brought a collective sigh of relief from state and local governments and the tax-exempt bond community This case centered around whether states violate the U.S. Commerce Clause when they tax a resident's out-of-state municipal bond interest while exempting in-state tax-exempt bond interest from taxation. Most states' tax policies are similar

to Kentucky's, making this case fundamental and significant. The court, in a 7-2 decision, ruled that states have the right to exempt taxation on in-state municipal bond interest while taxing interest on out-of-state municipal bonds without violating the U.S. Commerce Clause. Justice David Souter delivered the opinion, with Justices Kennedy and Alito dissenting.

The Court ruled that because issuing bonds is a traditional government function, and because setting different tax policies does not constitute economic protectionism, there is no violation of the dormant commerce clause. The opinion also states that invalidating a century-old taxing practice would cause "financing for long-term municipal improvements to change radically," noting specifically the hardship that would be borne by smaller municipal bond issuers that benefit from single-state municipal bond investment funds that are currently available to investors. The court did not consider whether preferential tax treatment for private activity or 501(c)3 bonds is in violation of the commerce clause. However, a footnote remarks that such a determination could "disrupt important projects that the states have deemed to have for public purpose." The Government Finance Officers Association (GFOA) and other state and local government organizations filed an amicus brief with the court in support of Kentucky's position. A copy of the court's opinion and the GFOA's amicus brief can be found on the federal government relations page on the GFOA's Web site, at www.gfoa.org.

Earlier this spring, the House

Financial Services Committee held two hearings to address the turmoil in the municipal bond market. The hearings called into question...