Municipal Bond Forum
On Justices Seem to Lean Toward Kentucky in Davis Case
Q
Suppose the Supreme Court rules against Kentucky in the Davis tax case. I have California tax-exempt bond funds and I’m concerned. How much revenue would California forgo if it exempted all bonds from tax to be able to continue to exempt their own, and wouldn’t exempting all bonds make California’s worth less than they are now? It would seem that since national tax-exempt funds have higher NAV, higher yields and are paying a higher distribution yield than state-specific funds now, state-specific funds would only decline further in value compared to the national funds when state-specific funds lose the distinction of being tax free for the residents of their states and become the same as the bonds from all other states. I think it may be a good idea to transfer out of California bonds into national tax-exempt fund.
A
James A. Klotz responds:
Right or wrong, we believe the Supreme Court will politicize its decision and rule in favor of Kentucky, but there’s no guarantee it will.
If Davis v. Kentucky is reversed, our guess is that high income tax states with budgetary issues, such as California, will tax the interest from their own issues rather than sacrificing the revenue collected by taxing out-of-state bonds. If this occurs, we agree with your observation that California issues will adjust to the national market, since California residents will be able to look elsewhere for higher yields. Curiously, it might also have the effect of lifting the value of bonds issued in low or no tax states, as the market seeks equilibrium.
The decision to transfer from your California holdings is a tricky one in light of the fact the Supreme Court has indicated that they were leaning toward Kentucky’s argument.
It’s really a tough call. Executing a transfer in advance of the Supreme Court decision could prove to be costly.
Start here.
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