Can someone comment on why municipalities charge a high bid premium on winning tax lien bids, and what happens to these funds since they don't incur interest. For example, I see a MD county charging a 20% premium on any bids that are higher than 40% of the cash or assessed value of a property. So am I correct in assuming a $42k winning bid on a property worth $100k would incur a $400 high bid premium.

$100k x .40= $40k, thus $2k x .20= $400 for a total purchase of $42,400 , of which the $400 is not interest bearing.

Is this a financial incentive for mortgage holders on a property to take FC action quickly?

Please correct me if Im not grasping the math.

My guess is basically to reduce the chance for bid-rigging. The DOJ is reviewing several cases of bid-rigging in NJ, where eight individual and two corporations plead guilty. I cannot say this is the true reason, but it does seem the most plausible to me.

Here is a more detailed explanation on the MD system. It does not give a reason why, but is more detailed and is easier to understand.

The purpose is to limit how high the bids are. 

A little history, it used to be any nice property in MD would get a $1,000,000 bid. (NOTE: In MD the bid amount is what you will pay for the property in the event you foreclose.) Investors bid this much because they wanted the 18%interest on the lien. They were wiling to walk away on the occasional lien that did not redeem. 

Obviously no one would foreclose on a property that was only worth $150K if they bid $1,000,000.  So the tax sale bidders would drag out their foreclosure cases for years hoping that eventually the owner would pay or the property would be sold and the taxes paid at settlement. This left many properties in limbo where the taxes were not bring paid.

To correct this situation the legislature came up with the high bid premium. Once you reach the 40% of assessment level, bidding any higher reduces your effective interest rate. This serves to limit the bids to a reasonable level. 

When the owner redeems you get your lien, interest on the lien, and the high bid premium back (with no interest on the high bid premium.)  If the owner does not redeem and you foreclose on the property  then the high bid premium gets applied to your purchase price (bid amount)

This is the process for MD. This will vary greatly by state.