Just as interest from U.S. government securities is exempt from state and local income taxes, interest from bonds issued by states and municipalities escape the grasp of federal revenuers. Known generically as municipal bonds, these tax-exempt issues usually carry a lower interest rate than fully taxable bonds. Investors make up the difference - and sometimes more - via tax savings.
The higher your marginal tax rate, the more valuable avoiding tax becomes.
To know whether municipals make sense for you, compute the taxable-equivalent yield - that is, how much you would have to earn on a taxable investment to have as much left over after taxes. See Taxable-Equivalent Yields for more information.
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