Stakeholders across the public finance ecosystem enjoy discussing hot topics. This is especially evident when we gather at the various industry conferences for a free and open exchange of ideas amongst peers. Tax proposals are typically top of mind, given the investor tax-exemption, a lower cost financing vehicle for issuers and the credit implications of adjusting certain state and local tax revenues. In my view, tax policies matter. Some matter at the margin, while others may have significant impact to both credit and technical considerations.
The federal tax exemption on municipal bonds is the singular most important tax doctrine in our business, shaping issuance trends, issuer budgetary flexibility, the demand from the buyer base, relative value and pricing nuances. We all witnessed last year's impact from just the perceived threat of the elimination of the federal tax exemption before passage of the One Big Beautiful Bill Act (OBBBA) gave comfort to the market.
While there were no direct threats to eliminate the tax exemption — which according to the Bipartisan Policy Center costs the federal government about $25 billion annually in lost revenue — it did appear on a list of "pay-fors" as OBBBA was being crafted. Although the legislation made permanent certain expiring corporate tax cuts, long-term implications for the national debt remain an ongoing concern and will likely influence long U.S. Treasury curve positioning at some point.
The November midterm elections are quickly approaching. Congress typically tries to avoid controversial major policy initiatives and/or those that come with outsized spending priorities during a key general election cycle. On November 3, 2026, all 435 seats in the House of Representatives and 35 (including a few special elections) seats in the Senate will be on the ballot. Republicans hold a narrow command in the House (220 to 213 with two vacancies), and they control the Senate with a 53 to 47 majority.
Generally, the party in control of the White House loses congressional representation in the midterms. The stakes are high this year, with the Democrats showing favorable polling, which could result in a power shift in the House. It would be more challenging for the Senate to turn blue despite the presence of some competitive races, so we may end up with a split Congress having thin margins of control. Should the Democrats assume a majority in the House, I would expect climate change initiatives, proposals for tax increases, and new regulatory oversight for businesses to potentially backdrop that chamber's core agenda.
While the federal tax exemption on the muni asset class stands, the fight for preservation remains ongoing and we should stay vigilant and not let our guard down under any circumstances. Over the years, legislation carved out certain tax-exempt muni allowances, making them no longer entitled to the exemption. Such actions largely enveloped private-activity bonds with specific implications for industrial development bonds and nonqualified private-purpose financings and others identified as arbitrage transactions. The Tax Reform Act of 1986 (The Act) clearly bifurcated the market between governmental purpose and private-benefit bonds.
The 2017 Tax Cuts and Jobs Act prohibited the use of tax-exempt debt for advance refunding purposes, eliminating an important lower cost debt management tool and confining tax-exempt refundings to a 90-day call window. The legislation only permits higher cost taxable bonds to advance refund outstanding debt and altered not only supply dynamics and intermittent relative value, but also issuer balance-sheet flexibility. Refunding math has become more challenging.
This impacts long-duration borrowers, including not-for-profit hospitals and universities, among other issuers. Any associated loss of debt service savings — which had previously been captured much earlier — could take away from smoothing out certain budgetary vulnerabilities, with weaker credits being most at risk. Further, issuers now have greater exposure to market volatility and refinancing risk. Although elevated taxable advance refundings have appeared, rates would have to drop to a compelling level to create a substantive shift from 2025.
Lobbying efforts continue to educate and pressure Congress to reverse the 2017 law and we have seen bipartisan proposals to reinstate tax-exempt advance refundings as an important debt-management tool in support of reducing capital infrastructure costs. In my opinion, a strong case to reinstate tax-exempt advance refundings must come from all parts of the municipal bond community, including lawyers, municipal advisors, sellside and buyside professionals and, of course, issuers. Industry advocacy groups — such as the NFMA, GFOA, SIFMA, NABL and CDFA — have provided an active voice.
Tax policy initiatives at the state and local level are actively ramping up in 2026. Arguably, some are more politically inspired than others and we have to question the practicality of any revenue impact should any of these measures pass. We are seeing specific proposals to levy wealth taxes in some areas, while efforts to rollback or eliminate property taxes are being debated elsewhere.
I tend to agree with research suggesting little outmigration associated with the imposition of higher taxes on the wealthy. Having said this, more and more states are debating this issue. Let's keep in mind that people and businesses relocate or remain in place for different reasons and they are not all tax-related. Family, community ties, affordability and overall quality of life, available amenities, career choice and business investment are other considerations. We also have to think about the level of wealth that is being sheltered and how much taxes are actually being paid.
While a standalone wealth tax is receiving all the buzz, certain states are already levying a wealth "surtax" on incomes in excess of a stated amount. While the natural inclination is to combine these types of taxes into one "tax the wealthy" bucket, there are distinctions. Politicians campaign on promises to impose a wealth tax, including Sen. Elizabeth Warren, D-Mass., during her presidential run. Thus, taxing the wealthy is not a new concept.
The imposition of a federal wealth tax has been the subject of widespread debate, with no clear resolution of its constitutionality. The idea of a wealth tax signals a tax on the value of accumulated wealth as opposed to a tax levied on income and generally considers net worth. The heart of the debate questions whether a wealth tax constitutes an income tax or a direct tax under Article 1 of the Constitution. An October 2021 policy paper prepared by the National Taxpayers Union Foundation (NTUF) provided three key facts. First, "a wealth tax is an unapportioned direct tax — and unapportioned direct taxes are unconstitutional."
Apportioned conveys that a tax is levied in proportion to each state's population. For example, California represents about 12% of the national population and so Californians would pay 12% of an apportioned tax. One can easily see why a wealth tax would not be viewed as apportioned.
The second fact presented in the NTUF paper is, "the unconstitutionality of unapportioned direct taxes is held in a long line of Supreme Court cases, most notably 1895's Pollack v. Farmers' Loan & Trust Co." The Pollack decision held that an income tax, also unapportioned, is a direct tax.
The third fact highlighted by NTUF is, "the federal income tax is an unapportioned direct tax, but is legal because the 16th Amendment modified the constitution to allow the federal income tax. A wealth tax would require a constitutional amendment, not merely a law."
This is where Sen. Warren's wealth tax proposal ran into a deeper analysis. Although her proposal did not specifically cite land or real estate in the determination of wealth, it did include personal property and so it would be difficult to consider land and real estate outside the boundaries of a wealth tax. Suffice it to say, the debate over a federal wealth tax extends beyond the real estate of this piece and the issue will likely be subject to intense judicial review.
To date, no state has officially adopted a true annual wealth tax based on aggregate net worth. This does not mean that states have not targeted high-wealth individuals for incremental tax revenue. Example applications include estate and inheritance taxes, capital gains taxes, mansion taxes, and my previously cited income surtax. In Minnesota, New York, Colorado, and Oregon, legislators have discussed wealth tax initiatives, but nothing has been approved to date.
Washington state, historically a non-income tax state and now with a negative rating outlook, has signed into law a 9.9% tax on annual personal income exceeding $1million on individuals and households effective 2028. This tax, as expected, is currently being litigated. The tax does not impact a significant number of taxpayers, but the state is facing a structural deficit of over $5 billion for the 2025-2027 biennium and is looking for ways to resolve the gap.
Whether this signals a seachange in Washington toward imposition of an income tax, only time will tell. According to a recent report by the Tax Policy Center/Urban Institute & Brookings Institution, voters in that state have overwhelmingly rejected state income tax proposals 10 times over the past 90 years.
In California, it looks like the state has obtained about double the required signatures to meet the minimum threshold to get a one-time 5% billionaires net worth wealth tax on the November ballot. Here, it is not yet clear what goes into net worth and I understand the tax would envelop worldwide net worth, further complicating matters. Also, collection timing is being worked through. I note that prior annual wealth tax legislation failed to garner approval in California.
The tax is estimated to raise about $100 billion over five years according to the Institute on Taxation and Economic Policy. New tax revenue would be used to fund healthcare, education and certain assistance programs. While labor supports the initiative, Gov. Gavin Newsom opposes the measure based largely on the risk of billionaire flight and potential budgetary pressure.
Part of the debate surrounds whether this would violate interstate laws, with other legal arguments against the proposal. Further, if you annualize this over a multi-year payment structure, the budget impact would be relatively small. While California has lost some billionaires, the outmigration has not yet been material. However, the top 1% of California taxpayers account for about 50% of total income tax receipts in the state. It is not difficult to see the potential downside of this measure.
Maine recently adopted a millionaires tax, but it is actually a 2% surtax on high income levels. The new levy impacts a very small percentage of filers and so I would not expect meaningful outmigration. Massachusetts has a 4% surtax on incomes above $1 million imposed since 2023, which gives us an adequate period to assess performance. Actual revenue is exceeding expectations with $1.3 billion collected in FY 2026 and about $6 billion since inception.
Interestingly, while data show some outmigration from high earners accounting for about 70% of the income outflow, more people actually left Massachusetts before the imposition of the tax, with the number of residents leaving the state declining after enactment. However, the income of those leaving is moving higher. So for now, there is no evidence of heavy tax flight, but we do have to monitor the level of income outflow over time and the potential impact on the Massachusetts budget.
While certain states are pursuing tax the wealthy initiatives, others are streamlining to flat taxes from graduated brackets as well as approving rate cuts as a way to retain competitive positioning. Tax Policy Center states, "since 2020, several states — including Arizona, Georgia, Idaho, Iowa, Louisiana, Mississippi and Ohio — have moved from graduated brackets to a single income tax rate. But the tax structures in these states started with different levels of progressivity."
Other states have lowered income tax rates while leaving graduated brackets in place, mostly benefitting higher income taxpayers, as reductions favor lower top marginal rates. Relief for lower- and middle-income taxpayers has been seen in very few states. The success or failure of these two different strategies will have to stand the test of time, but perhaps the results of this test will rest with the economic cycle and budgetary implications.
Property tax adjustments are another area of policy debate. As part of its FY 2026 budget legislation, Rhode Island passed its Non-Owner Occupied Property Tax Act (AKA Taylor Swift Act). The tax applies to non-owner occupied residential properties assessed above $1 million. Beginning in July 2026, qualifying properties that are not primary residences are subject to an additional annual levy of $2.50 per $500 of assessed value above the first $1 million.
The tax was marketed as a vehicle to procure funds for affordable housing within the state. Once the tax goes into effect, observers will look for population flight among top earners and potential changes for the coastal real estate market.
New York State Gov. Kathy Hochul and New York City Mayor Zohran Mamdani have proposed a similar annual tax on luxury second homes in New York City worth more than $5 million, referred to as a pied-à-terre tax. The tax would be imposed on one-to three-family homes, condos and co-ops. While the projected generation of $500 million is of little significance when measured against the city's total revenue of about $120 billion, the incremental taxes are expected to help close a projected $6.6 billion shortfall in FY 2028. Let's recall that Hochul does not support an increase in city income taxes for the wealthy, a key Mamdani campaign pledge.
Specifics of the pied-à-terre tax proposal remain unclear, but we do know that it would envelop a small amount of properties. The New York City Housing and Vacancy Survey reports an estimated 3,705,000 housing units in all of New York City with only about 59,000 (1.6%) used for seasonal, recreational or occasional use.
Not all of these units are necessarily valued at $5 million and therefore subject to the proposed tax increase. The bottom line — the tax, if enacted, will affect very few taxpayers, and would do little to address the city's housing shortage and affordability issues. Further, the city's property assessment methodology may undervalue certain luxury condos and co-ops for tax purposes and I am sure that many of these taxpayers will find a loophole to avoid the new tax if implemented. Having said this, future investment behavior could be impacted and the city will need to watch for any substantive declines in property values.
With this in mind, the Citizens Budget Commission of New York (CBC) reports New York State's share of the nation's millionaires decreased to 8.7% by 2022 from 12.7% in 2010. New York City's share dropped to 4.2% from 6.5% over the same period. While New York State's millionaires doubled in number during that time, the number tripled in California and Texas and quadrupled in Florida, resulting in the smaller percentage in New York.
The CBC further shows New York State is now fourth nationwide in the number of millionaires, dropping from second in 2021, and New York City's millionaires pay the highest personal income tax rates in the U.S. The CBC goes on to calculate a 2022 cost for the state and city loss of millionaires of $10.7 billion and $2.5 billion, respectively. In 2022, millionaires comprised less than 1% of state and city resident filers, but paid 44% and 40% of state and city personal income taxes, respectively. This statistic is quite telling and perhaps suggests a different approach would be appropriate.
In states that want to reduce property taxes, there needs to be replacement revenue or else their budgets will suffer, leading to wider structural gaps. It is very difficult to pull major funding sources, especially as local governments, school districts in particular, have grown to rely upon them. On the surface, these proposals sound great, but there must be an offset to backfill financial needs.
If implemented, Florida's proposal to enact a constitutional amendment to phase out most non-school homestead property taxes over time would have far reaching implications in my opinion, especially for cities, counties and special districts. Certain of these entities would likely have difficulty balancing their budgets and providing for essential services. The school district component tax would remain under the proposal. Upon receiving passage by both chambers of the state's legislature, the proposal would be placed on the November ballot and would need at least 60% voter approval.
Concurrently, variations of the proposal are being considered and the range of annual revenue losses is between $13 billion to $18 billion. As revenue replacement options, there is consideration given to raising the sales tax, implementing new fees and taxes and state revenue shifts. Elevating the Florida sales tax could erode the state's competitive standing.
As a Florida resident, I can tell you that while Florida is seeing an increase in AGI, net migration into the state has stalled since the COVID days. The cost of living in Florida has elevated with the state losing some competitive advantage despite the absence of a state income tax. We are seeing people bypassing Florida in favor of the Carolinas, Tennessee, Alabama, Arizona, and Texas.
Given the outsized increase in Florida housing prices, I am very skeptical that phasing out non-school homestead property taxes would materially lower the housing cost burden. Florida is also contending with exploding insurance costs and an overall mismatch between wages and cost of living. The risks of a material local funding gap with potential cuts to public services and elevated consumer costs may very well outweigh a lower tax burden.
Texas is also debating broad property tax relief along with considering new school funding models. Georgia, Indiana and North Dakota are also looking at property tax reductions.
Tighter immigration policies are also placing pressure on state and local revenue, particularly for those states that have historically relied on this cohort. Having said this, many of the "in vogue" states are becoming or will become expensive with erosion to competitive advantage. As population grows, demand for services, schools and infrastructure rises, placing upward pressure on costs. In many areas, we are witnessing a hollowing out of the middle class.
In my view, buyside conversations over these types of tax proposals are evolving with greater concerns. Many investors are actively reviewing their portfolios for potential falling angels and making adjustments where necessary. Top of mind will be the availability of alternative revenue sources, reserve levels, political willingness to proactively respond and strength of legal security.
General obligation and appropriation credits are likely more exposed than essential purpose revenue bonds, like utilities, airports, and non-tax supported transportation bonds. These sectors tend to be insulated from the vagaries of state and local general fund budgetary formation. However, material demographic shifts could impact these sectors.
Wealth taxes should not be viewed as a panacea, especially given legal challenges, enforcement uncertainty, and structural complexities. Property tax reductions would obviously have credit implications, especially for cities, counties and school districts. School districts are already under a great deal of budgetary pressure. These types of taxes should be considered in conjunction with state-level capital gains taxes, particularly in those higher capital gains tax states, such as California, New York, and New Jersey. Keep in mind that most states tax capital gains as ordinary income, and this tax is more susceptible to equity market volatility.
The federal SALT deduction cap was raised materially for 2026 to $40,400, but it moves lower for high-income households, some of which may be exposed to the old $10,000 cap. The higher cap is temporary and is scheduled to revert back to $10,000 in 2030 unless Congress takes action. For certain high-tax states, there may be less political pressure for tax cuts and affordability may improve. Further, there could be some reduced demand for in-state municipal bonds from upper-income taxpayers, which are not taxed in most states, in favor of taxable out-of-state paper as a portfolio diversifier.
Spreads, while compressed overall, could begin to widen, and so now is a good time to trade up in credit quality. Resident and corporate taxpayer mobility, tax base durability and potential revenue shifts should be closely monitored. Presently, for an inefficient market, the muni market is behaving efficiently. Demand for product is strong, and liquidity is not showing signs of impairment.
