It’s hard to imagine now, but at some point Congress and the administration will likely devote serious consideration to overhauling the tax code, including cutting rates.
Conventional wisdom posits, that may be a problem for the municipal bond market. After all, if the tax burden is eased, the thinking goes, tax-free bonds become less attractive.
But as with much analysis of the muni market, a closer look reveals a much different story.
For example, President Trump so far hasn’t released a detailed tax plan, but an overview disclosed last month calls for reducing the current seven tax brackets to three, with the highest rate cut from 39.6% to 35%.
Can we expect a 4 1/2-point reduction to be a game-changer? We doubt it.
As one analyst told the Bond Buyer, that drop “only takes you back to where we were under George W. Bush and before marginal rates were raised at the end of 2012.”
Plus, investors will still seek relief from rising state income taxes.
It’s important to note that an explicit goal of the administration’s tax efforts is to “eliminate targeted tax breaks that mainly benefit the wealthiest taxpayers.”
How will the plan pay for itself? With growth, administration officials said – along with reducing deductions and loopholes.
Again, we fail to see in this the death knell for municipal bonds, a highly popular tax-saving security.
Possible AMT repeal and muni bonds
Another aspect of the administration’s broad tax outline is repeal of the Alternative Minimum Tax. On that, an analyst told the Bond Buyer, it probably makes no difference to the market within the context of an overall plan: If deductions were cut or eliminated, the AMT wouldn’t be triggered, so repeal would be “a wash versus being an absolute negative for the municipal market.”
In fact, if deductions for state and local taxes were eliminated, that too would blunt the effect of AMT repeal, though it could increase the demand for munis from high-tax states, which might even trade at a larger premium, and it would narrow the yield gap between munis subject to the AMT and those that aren’t.
Of course, looming behind a tax overhaul is the threat of curtailing or eliminating the tax exemption on municipal bond interest. However, there’s no mention of it in the president’s tax outline, and he indicated support for it after last fall’s election (“Trump Surprises Mayors, Supports Muni Tax Exemption”).
As we have previously reported (“Voices Growing Louder on Muni Tax Exemption”), any attempt at such a move would be met with an outcry by state and local officials, who regard munis as a key tool to help finance infrastructure needs.
The muni market yawned
A look at the market shows no fear of significant tax changes. Since the election last November, municipal bonds prices have barely budged.
Ultimately, we think changes to the tax code, far from weakening the appeal of munis, could even enhance their value.
