Transcript
With the presidential election just around the corner, municipal investors are asking if there are any proposed tax policies that could impact the municipal bond market.
The major focus of investors tends to be on the 2017 Tax Cuts and Jobs Act. Some of its provisions are due to expire at the end of 2025.
Not surprisingly, there’s a lot of attention on personal income taxes. It looks like Trump may favor extending the Act’s tax cuts across the board, whereas Harris is expected to extend the cuts to single taxpayers earning less than $400,000 and joint taxpayers earning less than $450,000. Anyone making more than that would see the top marginal rate go back to 39.6%. So what does that mean for municipal investors? Well, higher personal income taxes would make municipal bonds more attractive.
I would also tell you that AMT, or alternative minimum tax, rules can affect the value of some municipal bonds. The 2017 Tax Act raised the AMT exemption, and that meant that the number of taxpayers subject to the AMT plunged to about 200,000. If the higher exemption expires, it could make a lot of taxpayers—more than 7 million, actually—AMT eligible yet again.
When the exemption increased, federal tax revenue was lost. The Harris camp might want to let the higher AMT exemption expire, whereas Trump would likely push to extend the current levels. We think the AMT exemption will probably be extended. A permanent extension could cause spreads to narrow on municipal bonds subject to the alternative minimum tax, which is about 4% of the market.
Now, what about the SALT deduction? The 2017 Tax Act put a $10,000 limit on state and local tax deductions, and that limit increased the tax advantage of municipal bonds, especially in states with higher taxes. But without changes, the cap will sunset, and the SALT deduction will become unlimited yet again.
Trump recently indicated he may restore the SALT deduction. Harris might be swayed to allow the cap to expire if the potential revenue loss can be offset through alternative tax sources. But if instead the cap is kept or even lowered, we think that would make munis and other in-state investments even more appealing.
Lastly, there’s long-term capital gains. Trump probably won’t change the current tax rate on capital gains, whereas Harris wants a maximum rate of 33%, which includes a 28% capital gains tax plus a 5% tax on investment income. That’s up from 3.8%. Why is that important for municipal investors? Well, we think higher capital gains taxes could lead investors to delay taking gains. What do I mean by that? Investors could hold onto positions longer, thus potentially lowering turnover in portfolios.
Investors tend to worry about whether elections will have an effect on their municipal returns. But we don’t think they need to be too concerned. And that’s because past presidential elections have had very little bearing on municipal market returns. What we think investors should focus on is the bigger picture—which is that municipals remain attractive: Yields are high, valuations are compelling, issuer fundamentals are strong—and to us, munis are a worthy candidate for long-term investors.