Question

1. Exempting the interest on state-local government bonds from federal income taxation is the lowest cost way for the federal government to subsidize state-local borrowing costs.” Evaluate this statement.

Answer 1

Whenever state or local govt. need money for public works projects ( like constuction and maintenance of bridges, schools hospitals,water works etc) ,they raise it by issuing bonds to the investors. # These investors provide money to state or local govt and the govt in return promises to pay them interest on bonds ( coupon) plus principal amount . #Thesr investors may be general public, corporation or other private bodies. #The federal govt generslly exempt this interest on bonds from federal income tax. Why federal govt exempt from tax_--------------:. *To provide economic assistance to the state or local govt ,is one of the basic functions of federal govt.and providing exemption from income tex acts as a financial assistance to local govt or local govt.. *The state govt uses this money collected through issue of bonds,,for public welfare, which is in turn the overall function of federal govt. How tax exemption works as lowest cost way to subsidize local borrowing----------------: . *Whenever,federal govt gives tax exemption on bonds' s interest,ot works as a boon to staye govt. *State govt can borrow more cheaply than other debt issuerd,which helps state govt a lot to get cheaper funds* The federal tax exemption works as the federal subsidy to state govt . In short ,i can conclude that by exeption income tax from bonds interest ,the federal or central govt helps local or state govt ,which works as two way---- first ,it provides subsidy through tax exemption, secondly ,it costs very low to federal govt ,as it has to only sacrifice federal income tax,,,this wY it is lowest cost borrowing....I.hope this answer will help you