It took Congress more than 1,000 pages to detail their tax overhaul, but investors in high-tax states understood the upshot of one provision immediately: Their taxes were about to go up – and municipal bonds would be particularly appealing.

Among a host of changes, the tax law passed at the end of last year capped the federal deduction for state and local taxes at $10,000, prompting a surge in muni demand from investors in high-tax states, especially California and New York, according to Barron’s.

Demand also spiked in other states, like Connecticut, which attracted record orders from retail investors for a recent general-obligation offering.

Tax Overhaul Fueling Muni Bonds Demand

Hand-wringing over the tax overhaul

When the tax overhaul was initially approved, many financial pundits saw dark clouds on the horizon.

They figured lower corporate taxes would dampen demand for munis and negatively affect the municipal bond market.

But individual investors didn’t need a crystal ball.

For them, the calculus was simple: On an after-tax basis, the value of munis far outweighs taxable alternatives.

Consider a married couple in New York City.

They face a whopping 51.53% marginal tax rate.

A 3.00% municipal bond for them is the after-tax equivalent of a 6.19% taxable bond.

Even some out-of-state municipal bonds would make sense for them.

Increased market for munis in high-tax states

As we have noted (“Roller Coaster Quarter for Muni Issuance”), demand for munis is strong and the number of affluent people in high-tax states such as New Jersey, New York and California is growing, which should further expand the market for tax-free bonds.

Within the massive tax overhaul, it’s easy to get lost in the thicket of provisions.

Add in the headlines over potential changes in interest rates, further tax modifications and a host of other financial news and it’s easy to see how some investors could lose sight of what’s important.

The cost of waiting

Selecting municipal bonds hasn’t changed.

Analyze quality first, then yield.

Tune out the noise and soothsayers.

Most of all, avoid the paralysis that can be induced by the plethora of often conflicting headlines.

Investors who keep their cash in money-market accounts while waiting for the “right” time to jump into the municipal bond market are losing out on tax-free income they’ll never recover – an axiom as true today as when we first began discussing it (“The Cost of Waiting: 2nd Anniversary”).

No wonder the tax overhaul didn’t deter muni investors.

After all, it’s difficult to conceive of an environment in which generating a juicy stream of after-tax returns wouldn’t be attractive.

James A. Klotz is the President of FMSbonds, Inc. Email the Author 09/07/2018