How are municipal bond investors viewing the idea of eliminating the tax exemption on interest income?
Mostly, with indifference.
As we have discussed, (“13 Words That Could End the Muni Exemption”), Congress and the president are looking for ways to raise money to pay for trillions of dollars in tax cuts.
Unwisely, they are considering wiping out tax-free bonds.
Although municipal professionals are concerned, the market hasn’t flinched, according to a report in The Bond Buyer.
Many think the exemption will mostly survive. The potential revenue from such a move would barely make a dent in what’s needed to pay for the tax cuts. Also, eliminating the exemption is fiercely opposed by state and local budget officials, who rely on munis to fund public infrastructure.
As the debate continues, managers are not “making any portfolio moves yet based on potential policy shifts in Washington,” according to the report.
More issuance, more demand
Suppose, however, the exemption is eliminated?
For starters, there would likely be a cascade of issuance before the law takes effect – which would probably be met with voracious demand. In that case, the market would likely remain stable.
“So you wind up with a uniquely, near-unchanged equilibrium point in terms of valuation that doesn’t lead to any meaningful moves,” Wesly Pate, a senior portfolio manager, told The Bond Buyer.
Private activity bonds
While many think the exemption will remain at least largely intact, we are wary. Tax-free municipals have been attacked before.
Back in 2017, advance refunding bonds were eliminated to help pay for tax cuts that were part of the Tax Cuts and Jobs Act.
A Republican member of the House Ways and Means Committee recently told Bloomberg he’s in favor of maintaining the exemption. Instead of repealing the exemption entirely, he said, the costs and impact of private activity bonds may be scrutinized.
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Private activity bonds are tax-free municipal bonds used to attract private funds for projects that have some public benefit. For example, qualified projects have helped build hospitals, airports and affordable housing.
Investors plow forward
The talk has left individual investors undaunted. They continue to take advantage of a highly attractive market in which the recent tax-equivalent yield on 30-year, A-rated bonds was a whopping 7.46% for those in the 40.8% bracket.
With appealing bond yields and exceedingly volatile equities, it’s no wonder investors continue streaming into the municipal market.
Given the importance of tax-free bonds to the country and investors, the only mystery is why some are bent on decimating them.