First Read on What the Tax Plan Means for Munis

The House released their much anticipated tax plan last week, which in general, is supportive of municipal valuations. From a corporate tax standpoint, the highlights of the plan include a reduction in the corporate tax rate to 20%, adjustments to the taxation of foreign earnings and changes in the way capital expenditures are expensed. The tax rate on pass through business income would also be reduced. From a personal tax standpoint, the top individual rate remains at 39.6%, though there is some reshuffling in the brackets. There were also changes to the deductions for state and local taxes and an elimination of the AMT.

Republicans have been searching for additional revenue generators to help finance their proposed tax cuts, but taxing municipal bond interest was not one of them. Some changes to municipal taxation were included, however. The plan includes eliminating the tax exemption for advanced refunding bonds, which are essentially bonds municipalities issue to refinance existing debt. It also eliminates the tax-exempt status for bonds issued to finance private activities (think public private partnerships for transportation and housing projects) as well as bonds issued by non-profit healthcare and higher education providers. The tax-exempt status of bonds already issued by these entities will be grandfathered in. 

On net this is a good outcome for municipal bond valuations as the tax-exemption for the vast majority of municipal issuers is maintained and individual tax rates are unchanged for high earners. Supply may also fall because of the changes to the treatment of advanced refundings. As we have written about in the past, the true wildcard for the muni market is the reduction in the corporate tax rate. Banks and insurance companies are large buyers of municipal bonds and have taken up a larger and larger share of municipal holdings in recent years. A decline in corporate tax rates may make municipals less attractive for these entities. 

All of this should be taken with a grain of salt as this initial proposal is far from complete. The bill now goes to committee, where significant changes could be made. As a first step, however, the strong performance that municipals have put in throughout 2017 appears safe to continue. 

Source: Morgan Stanley, Tax Foundation