Page 32 - December 19. 2024 Bulletin

BUSINESS PARTNERfeature article

Repercussions of

Tax Policy Changes

for Municipal Bonds

Dana Sparkman, CFA
Senior Vice President/
Municipal Analyst
The Baker Group

looming expiration of the Tax Cuts and Jobs Act (TCJA) of This means that broad market demand is predominantly
2017 and Republicans in narrow control. While it is too driven by individuals rather than corporations. Assuming
early to know concrete tax plans from President-Elect Trump’s individual tax rates are not further cut, individuals should
second term, we have some insight into what he would like still have strong demand for tax-exempt income. However,
to implement as stated on the campaign trail, including the entities subject to the corporate tax rate may continue to
following: struggle to find value in tax-exempt municipal bonds.
• Extend most provisions of the Tax Cuts and Jobs Act Threatened Tax Exemption
(TCJA) of 2017, except the State and Local Tax (SALT)
deduction cap may be raised or eliminated. The ability to obtain tax-exempt financing is a tremendous
• Lower the corporate tax rate to 20% generally, and to benefit for state and local governments. However, municipal
15% for domestic manufacturers. market experts caution that this benefit may be vulnerable
due to tax cuts coupled with the recent focus on the national
• Exempt income derived from tips, overtime pay, and debt. The Tax Foundation reports that if all tax proposals
social security from taxes. touted on Trump’s campaign trail were enacted, the effect

How these items will be paid for is largely a guessing game at would be a $3 trillion increase in the 10-year budget deficit.
this point, but municipal market participants worry that possible Eliminating the tax exemption on all municipal bonds
“pay-for” options may harm the municipal market. Some key could offset about $36 billion per year according to the
potential impacts on the municipal bond market are discussed Congressional Joint Committee on Taxation. That is a small
below. amount in exchange for being detrimental to financing of
local infrastructure. Therefore, it seems unlikely this will
Demand happen.

The common theme of Trump’s wish list is a low tax burden A more likely scenario is that a segment of the municipal
on American taxpayers and companies. All else equal, market may lose its eligibility to issue tax-exempt bonds
demand for tax-exempt income diminishes as tax rates similar to the way advance refunding bonds were obstructed
fall. Individual tax rates are currently expected to remain at by the TCJA in 2017. Private Activity Bonds (PABs) were
present levels (top rate of 37%), and general corporate tax considered for repeal of the tax exemption when the TCJA
rates may fall slightly from 21% to 20%. was passed, but ultimately retained their tax exemption for
qualified purposes then. PABs are likely to be targeted again.
SIFMA data shows that over 70% of municipal bonds Legislators may look to other segments, such as hospitals or
are held by individuals and mutual funds rather than by colleges, as additional options to repeal the tax exemption
corporate taxpayers, as shown in the chart below. This was and raise revenue. Borrowing costs would rise for any issuers
the case even before the TCJA slashed corporate tax rates. that lose the ability to issue tax-exempt bonds, which could

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