Also known as “munis,” municipal bonds are debt obligations issued by the state and local governments and other governmental entities to fund the building of highways, hospitals, schools, sewer systems and many other public projects. Munis are attractive to investors in high tax brackets because, in most cases, the interest income is excluded from federal income tax calculations. If investors own municipal bonds issued within their states of residence, interest income may also be excluded from state and local taxes.

Taxable municipal bonds are an entirely separate market within the municipal sector where interest income is included in federal income tax calculations. However, these issues still offer a state–and often local–tax exemption to investors residing within the state of issuance. Taxable municipal bonds exist because the federal government will not subsidize the financing of certain activities that do not provide a significant benefit to the public. Investor-led housing projects, local sports facilities, and borrowing to replenish a municipality’s underfunded pension plan are three types of bond issues at at are federally taxable.

Yields on taxable munis are typically comparable to those of other taxable issues, such as agencies and corporate bonds. i vestment in municipal securities may not be appropriate for all investors, particularly those who do not stand to benefit from the tax status of the investment.