“Municipal bonds avoided all the various proposals that had been put forth to eliminate or reduce the level of their tax exemption. In fact, the increase in the top marginal income tax rate to 39.6% from 35.0% may make municipal bonds even more attractive to some high income investors,” Strauts wrote in a profile of MUB, the largest muni bond ETF. “After a sell-off in December the municipal-bond market has rallied as investors have shaken off concerns about potential changes to muni bonds’ tax treatment in the near term. But the long-term tax status of municipal bonds is far from resolved in Congress.”
A study released by the U.S. Conference of Mayors on Monday said limiting the tax exemption for the interest paid by U.S. municipal bonds would not only make borrowing more expensive for cities, counties and states, but would also drag on economic growth while driving up unemployment, according to a separate Reuters report.
“Not since the Reagan administration has the municipal market been faced with a significant rewrite of the tax code,” reports Jeff Westergaard, Morningstar’s director of municipal analytics. [Muni Bond ETF Discounts May Signal Buying Opportunity]
“Recently proposals have been put forth that would drastically affect the tax treatment of municipal-bond income, with the most significant being a limitation on the tax benefit at 28% of gross income. The primary drivers for municipal-related proposals have been revenue considerations and deficit reduction,” he added. “In our opinion, this issue has lost some of the dominance it held from late 2011 through the election, though that may prove temporary. Whether there is consensus to move forward with these new radical approaches remains to be seen, given the partisan dysfunction in Washington, but investors would be well served to keep an eye on developments.”
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