How will the tax reform plan impact municipal investing?
I have some municipal funds in my portfolio. The yields are low but are exempt from Federal taxes. How will the new tax reform plan impact municipal investing?
Tax reform will decrease tax liabilities for both individuals and corporations. And bond issuance could increase to help support the infrastructure spending the Trump Administration has apparently proposed. How all this will affect municipal bonds is still uncertain.
By reducing marginal tax rates for most individuals and corporations, municipal bonds should remain an attractive option for individual investors.
Although on the corporate side, lowering the corporate income tax rate could potentially affect demand because muni bonds would become less attractive relative to corporate bonds for institutional buyers.
First off, municipal bonds will still be attractive to individual investors because although taxes have been cut, they are still relatively high, making muni's tax exempt nature valuable. The limitation on deducting state and local taxes would make munis that are exempt from state and local taxes very attractive to investors. At the margins changes to AMT (higher exemption and phase out) will make munis subject to AMT attractive and private activity bonds will continue to find buyers. Some other elements of the bill such as mortgage deduction limitation could have a tangential effect on the muni market.
Corporations (Especially banks and insurance companies) may not find muni's as attractive at a 21% tax rate as they did at the 35% tax rate, however it may take months or years for this to play out and companies will continue to find munis to be a good diversification to their bond portfolios.
The bottom line is that munis will continue to be attractive and if you are investing through a fund run by a talented manager then he/she should be able to add value to your portfolio.
The overall impact of the tax reform bill is mixed and will take a while to play out. It’s very difficult to tell to what degree tax reform will impact muni investing, as the bill was passed very quickly. Everyone is still reading it, even those who voted for it. From what can be discerned thus far, all 3.8 trillion in muni bonds will remain federally tax-exempt. In addition, the bill still allows for issuance of new muni debt. However, it is likely that we see a reduction in gross issuance, due to some shifts in the advanced funding rules. the bottom-line, the tax reform bill will likely have a neutral to slightly positive impact on municipal investing.