Several pending tax proposals that do not deal directly with municipal bonds could end up affecting the yields of tax-exempt debt, experts say, but most of this legislation does not stand a chance of winning final approval by Congress at least until next year.
Tax proposals that inadvertently could influence the demand, supply, and yield of debt sold by states and localities include: reductions in or reform of the marginal tax rate; the estate tax; the alternative minimum tax; retirement savings-accounts; and the marriage tax-penalty, according to observers such as George Friedlander, a Salomon Smith Barney Inc. strategist who outlined the possible effects of such legislation in a recent report.
The only plans that have a decent chance of passage this year are the estate tax and retirement-savings-accounts provisions, a legislative analyst said. And the prospects for next year are sketchy because they largely depend on whether Vice President Al Gore or Texas Gov. George W. Bush wins the presidency, as well as on which party controls the House and the Senate after this year's election.
Of the proposals, a reduction of the marginal tax rate may be the one that most clearly could end up affecting the muni market. Bush has proposed cutting the top tax rate to 33% from 39.6%, and making similar reductions in lower tax brackets.
"A cut in the top rate of this magnitude would almost certainly cause short- and intermediate- municipal yields to increase," Friedlander said in his report, because the tax-exempt benefit associated with muni bonds would be reduced.
Brad Gewehr, managing director of PaineWebber Inc.'s municipal research group, agreed. As an example of the correlation, he pointed to California, where he said the state's relatively high tax rate affects the muni market.
"If you look at the yield of California paper right now ..., it is low," Gewehr said. "There is high investor demand for tax-exempt bonds among California-based investors because the value of that tax-exemption is so high. That's one example of the impact of marginal tax rates."
The likelihood of a marginal-tax-rate cut is slim if Gore becomes president or the Democrats win control of either the House or Senate, said Stephen Slivinski, a Cato Institute fiscal policy analyst. That is because Democrats traditionally are more interested in selective tax cuts that fit their political agenda, he said.
Friedlander's report pointed to estate tax cuts as potentially "positively, affecting demand for municipals by increasing savings rates, and by reducing or eliminating the need to liquidate holdings to pay estate taxes." Congress yesterday sent a bill that would gradually eliminate the estate tax to President Clinton, who has threatened to veto it. But the bill might be able to survive a veto because it has close to a veto-proof majority in both chambers, Slivinski said, adding that he is "surprisingly optimistic" about the bill's prospects.
"That of course would send a very strong signal to capital markets generally that both Democrats and Republicans would be more willing to reform the tax code to make it more capital friendly," he said.
Friedlander also said some form of AMT relief is likely over the next few years, but added it is "not clear how much this relief would help demand for AMT municipals."
AMT relief currently does not appear to be on the front-burner.
"It's more difficult to explain AMT reform to people," Slivinski said. "In a year where you have a presidential election, which is entirely dependent on easily explainable concepts, AMT tax reform is probably going to be a hard sell to anyone just because of the sheer complexity of it."
