By Hilary Russ
Oct 10 (Reuters) - The national trade group representing U.S. bond dealers announced on Wednesday the formation of a coalition to defend the tax-exempt status of municipal bonds, a key trait of the $3.7 trillion market.
Tax exemption for munis is under threat as Congress considers narrowing the U.S. budget deficit with spending cuts and new sources of revenue for the federal government.
Ending or limiting tax exemptions for munis could cause investors to pull out of the market and raise borrowing costs for states, cities and other issuers, according to Municipal Bonds for America, the new group.
"Policy makers should not try to fix what isn't broken," said the group's co-chair Ken Williams, municipal bonds manager at Stifel Nicolaus, in a statement. "A tax on tax-exempt bonds ultimately shifts more burdens to local governments."
Organized by the Bond Dealers of America, the coalition comprises about 25 muni bond dealers from middle-market securities firms. It also includes a local Tennessee official, the executive director of the National Association of Local Housing Finance Agencies and others.
The group will conduct research and lobby Congress. It expects to add issuers, academics, local elected officials, analysts and investors to its ranks in the coming weeks.
The Revenue Act of 1913 first codified that muni bond earnings were exempt from federal income taxes. Tax reform in 1986 restricted the exemption to public purpose bonds and made many bonds issued for private activities subject to the alternative minimum tax.
U.S. President Barack Obama included tax-exempt municipal bond interest in legislation in September 2011 and again in his proposed 2013 budget in February.
Obama proposed limiting the value of the tax exemption to 28 percent from the current 35 percent for high-income taxpayers.
Advisers to Republican Presidential candidate Mitt Romney have indicated that tax-free munis are on the table in terms of tax reform, according to a previous report by the Bond Dealers of America.
Observers don't expect significant movement on the issue until after the end of the lame-duck session following the presidential election.
(Additional reporting by Lisa Lambert; Editing by James Dalgleish)
Keywords: MUNICIPALS TAXEXEMPTION/