The experts spoke as part of a panel, “Muni-Bond Tax Exemption Under Active Attack,” at the Securities Industry and Financial Markets Association Municipal Bond Summit in New York City.
In Washington, the Democrats primarily view munis’ usual exemption from federal taxes as something that helps the wealthy, according to RBC Capital Markets head of U.S. municipals strategy Chris Mauro. On the other hand, Washington Republicans see munis as part of the problem of government spending. “Now it seems that munis don’t have anyone in their corner from either side,” Mauro said.
There is a “massive” problem with the federal deficit, he said. The Democrats will probably retain control of the Senate and the White House, Mauro added. Given that, the most likely scenario next year with regards to the muni tax exemption is that President Obama’s proposed 28% cap on the exemption will be adopted.
In September 2011 Obama sent a bill to Congress that would have limited the tax value of tax-exempt interest from munis, other expenditures, and deductions to 28% for all individuals with $200,000 or more of taxable income and married couples with $250,000 or more. It would have applied to taxable years beginning on or after Jan. 1, 2013. There would have been no grandfathering for the tax-exempt bonds investors held.
From the audience, Citi senior municipal strategist George Friedlander said once the federal government set a 28% cap on the muni exemption, that could just be a first step of the tax exemption’s further elimination.
For the exemption rollback to yield the federal government significant amounts of money, it would have to be lifted on existing bonds as well as future bonds, Mauro said.
A rollback of the exemption would hurt issuers selling bonds less than $20 million, said HJ Sims & Co. director of credit analysis Richard Larkin.
Ending the exemption would not be all bad for munis, according to Loews Corp. senior vice president Mark Muller. Making them taxable would expand the range of people who would be interested in buying them, he said. Presumably, that would be because they would then offer yields competitive with other fixed-income investments.
In a second panel at the SIFMA conference on the secondary market, an audience member asked what the impact of the Volcker Rule would be on the secondary market. How it will play out is unclear, said Citi co-head of municipal capital markets Peter Bartlett. However, dealers are already getting ready for it by taking less risk and holding bonds for less time. The federal introduction of the rule could be a negative for liquidity, Bartlett said.