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Pure flat tax doubtful


I think tax-exempt bonds are great but what do you think will happen to bonds when Congress passes a flat tax?

D., California


James A. Klotz responds:

We think any change in the current tax code would be designed to have very little impact on the municipal bond market.

Although we don’t envision the enactment of a pure “flat tax,” the tax-reform committee may recommend some version of a “consumption” tax. Most of the consumption tax proposals that are being discussed still project higher tax rates for wealthier taxpayers, who would still invest in munis for higher after-tax yields.

There are other reasons that suggest the effects on the municipal bond market would be minimal, including:

* Yields on long-term AAA tax-free bonds are pretty much the same today as the yields on long-term Treasury bonds. This means they are already inexpensively priced compared to taxable securities.

* The municipal bond market was created to allow states, municipalities and political subdivisions to borrow at reasonable rates for construction of “public purpose” projects (sewers, schools, etc). Since the public cannot afford to compete in the private sector capital markets, some mechanism would be required to accommodate borrowing for public projects.

Powerful private interests, the budget deficit and the Alternative Minimum Tax problem make us less than optimistic that any tax reform package will be enacted over the near term.

Nov 30, 2004

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