Thumbs down on Obama’s muni tax
Unsurprisingly, the Treasurer of California and Bloomberg’s editorial board are pushing back on the Obama administration’s proposals to reduce the municipal bond tax exemption for those earning more than $200,000 per year. I wrote previously how the Republicans are cool to the proposal. The California Treasurer says that the increased tax would raise municipal borrowing costs and estimates that over time the act could add $2.7 billion to $7.7 billion to statewide borrowing costs. Bloomberg’s editorial board goes further and suggests that any changes to municipal bond taxation should be done as part of a broader tax reform effort. From Bloomberg:
How disruptive would this new tax, which the administration estimates will bring in $30 billion a year, be for the muni market? A report from Morgan Stanley Research saw little impact, pointing out that the premiums investors demand to hold munis over Treasuries “have little direct relationship with tax rates historically.” A report from Citigroup Global Markets, by contrast, argued that curbing the exemption would “increase state and local borrowing costs significantly.”
On balance, we suspect the impact on interest rates will be relatively small initially. (Certainly the proposal has had little effect on the market since the announcement, according to Bloomberg pricing data.) Of course, that could change rapidly if historically low Treasury yields rise and munis start to look less attractive.
If the aim is to help states build infrastructure and create jobs, Obama’s proposal starts to look somewhat unserious, given that it would probably make public-works projects more expensive. When one considers its chances of passing in Congress — approximately 0.0 percent, according to the latest Bloomberg View calculations — it starts to look downright disingenuous.
One element of the discussion which has been left out is that the U.S. municipal market has been shrinking and that individuals hold only about 29% of outstanding municipal bonds. Reuters reports: