WASHINGTON — President Obama’s call for Congress to pass a one-year extension of the Bush tax cuts for families earning $250,000 or less would boost demand for municipal bonds, market participants said Monday.
While Obama’s proposal was seen mostly as political posturing ahead of the November election, many market experts said that, if enacted, it would make municipal bonds more attractive to taxpayers making more than $250,000. The 35% top marginal tax bracket would increase to 39.6%, leaving many investors seeking alternative investments, they said.
“In general, if overall exposure to taxes goes up, the need for a tax shelter goes up as well,” said Matt Fabian, a managing director at Municipal Market Advisors.
Chris Mauro, head of U.S. municipals strategy, at RBC Capital Markets, pointed out that the same class of taxpayers making more than $250,000 would also be hit with a 3.8% surcharge on investment income next year as part of the health care reform bill.
“It would be a double whammy and would make munis more attractive,” he said.
However, Chris Mier, a strategist at Loop Capital, said there would be a primary and a secondary impact to such a proposal. Initially there would be more demand that would be spread equally across the yield curve, causing prices to rise proportionally, he said. But if yields go down, people making $250,000 or less will suddenly face a different supply curve, according to Mier.
As a result, there will be less demand from those earning up to $250,000, which will offset the demand from wealthier investors.
Mier also said that if the yields are lower on munis and Treasury bonds, the market would see more refunding activity.
Historically, it’s virtually impossible to discern any change in the marginal tax rate by observing a simultaneous change in the ratio of muni yields to Treasury yields, he said.
“There are offsetting factors that make it difficult to tell if anything will happen,” Mier said. “I don’t think it will be a big deal. It’s not an overwhelming change in the tax rate and it’s not an overwhelming number of people it applies to. Most of these people have more sophisticated tax shelters.”
George Friedlander, an analyst at Citi, was also skeptical that Obama’s tax proposal would have a significant impact on the muni market. He said investors don’t change their behavior based on a one-year proposal because it could be changed again within a year after the election.
Friedlander highlighted the uncertainty surrounding the proposal, including how it would be paid for. He said it’s possible it could be paid for using Obama’s 2013 budget proposal to place a 28% cap on the value of tax-exemption. However, it’s unlikely Republicans would sign off on it.
Obama warned that if Congress does not extend the Bush tax cuts, families could see their taxes increase by $2,200 starting in January 2013. “It’s time to let the tax cuts for the wealthiest Americans — folks like myself — to expire,” Obama said.
Democratic leaders were largely in step with Obama’s proposal, even though earlier this year House Minority Leader Nancy Pelosi, D-Calif., and Sen. Chuck Schumer, D-N.Y., broached the idea of extending the tax cuts for taxpayers who earn up to $1 million.
Senate Finance Committee chairman Max Baucus, D-Mont., praised Obama’s proposal while stressing the need for tax reform. “We need to work to overhaul the nation’s tax code to reduce the deficit, create jobs and strengthen the economy,” he said in a release.
The Republican-controlled House is expected to vote for a one-year extension of the Bush-era tax cuts before the August recess, which would maintain cuts for wealthier Americans.
Republicans denounced Obama’s tax proposal. “Keeping taxes low is still the right thing to do to get the economy growing again,” House Majority Leader Eric Cantor, R-Va., said in a release.
Congress last extended the Bush-era tax cuts for two years in December 2010.