MuniLand: Do You Have Tax-Phobia?

Halloween is approaching and year-end tax planning may be starting for a few of us. At this time of year, irrational fears such as arachnophobia and tax-phobia may be getting the better of us. Tax-phobia, the fear of paying taxes, is not a clinically defined disorder, but it has real implications for the municipal bond market. Muni bonds benefit from tax-phobia because of their tax-free income status, and from almost everyone’s aversion to paying taxes. However, there are times when the municipal market becomes rich relative to the taxable market.  When this happens, only households in the very highest tax brackets benefit from the tax-exempt income status of muni bonds. Now is one of those times. Municipal bonds maturing within five years are pricing as low as 65% of Treasuries. That means that just to break even in capturing the tax exemption benefit from municipal bonds your marginal tax rate must be 35%, and that doesn’t account for any sort of liquidity or credit quality premium that should be demanded versus a Treasury bond. In California the issue is even more acute. For example, Los Angeles’ Department of Water & Power (Aa3/AA-) came to market this week with $450 million in debt. The 5 year bond in this deal priced at a negative spread to benchmark AAA municipal securities of comparable maturities, equating to 63% of comparable maturity Treasury bonds. If you are in the highest marginal tax bracket, a tax-exempt portfolio remains an attractive investment strategy. If you are not in the highest marginal tax bracket, our Blend Strategy takes advantage of relative value in the bond market and avoids overpaying for tax-free income. Remember, if you suffer from tax-phobia SNWAM can help.