Is interest on Savings Bonds taxed at dividend rates or ordinary income rates? Do you pay state tax on US government bonds? Tom's response Savings Bonds pay interest income that is taxed at ordinary tax rates. States aren't allowed to collect income tax on Federal interest payments, including Savings Bond interest, but you need to make sure you take the deduction on your state taxes. It's not automatic. For more information, see our web page on avoiding state tax on your Savings Bond interest.