Munis: First Take on the House Tax Bill

Author: John R. Mousseau, CFA, Post Date: November 3, 2017

The House bill proposes to keep a 39.6% top rate. Thus there will be no reduction on the demand side for munis for individuals.

The corporate rate is lowered to 20% from 35%. The lower rate may hurt corporation demand for munis, most likely in shorter-term maturities since their yields are far lower than Treasuries yields. The longer end of the muni market remains cheap to Treasuries, so we don’t see much change there. At the margin, buyers may prefer other taxable bonds to munis, but at current tight yield spreads we expect the fall-off to be minimal.

SALT (state and local taxes): The ability to deduct property taxes remains in effect but is capped at $10,000. There will be plenty of grousing from high-tax states. We expect the cap to rise before a bill is passed.

State and local income taxes will NOT be deductible on federal income taxes. This will have three effects. First, citizens will put pressure on states to roll back state taxes – at least to a level where part of the deductibility loss is made up. In addition, look for states to push services and expenses down to the local level as states try to keep the deductibility-issue backlash contained. Finally, the lack of deductibility will mean further migration from high-tax states like New York, New Jersey, Massachusetts, and California to low- or no-income tax states like Nevada, Texas, and Florida. This change will also boost the demand for bonds in high-tax states. There will be less reason to own out-of-state bonds in places like New York, New Jersey, and California, as the state taxes paid on income from out-of-state bonds will no longer be deductible.

Private Activity Bonds issued for stadiums will be phased out next year. This means that that if municipalities want to issue bonds for arenas and stadiums, they will have to do so in the taxable bond market. This will mean more financing by owners, which in the end should keep municipalities from being on the hook for bad stadium deals.

The bill repeals advance refunding bonds. Under a provision of a bill, issuers will be able to issue refunding bonds only as CURRENT refundings (that is, 90 days or less before the redemption date). This will HURT municipalities that have been able to save billions of dollars collectively by issuing advance refunding bonds in which they defease 5% plus original yields with 3% plus additional yields. We expect this provision to be taken out before a final bill is passed. Taking away the ability to benefit from lower interest rates hits municipalities just as they are trying to get a grip on pension issues.

While the standard deduction is nearly doubled and the mortgage deduction is kept intact for existing homes, mortgage interest will be capped at $500,000 for any new purchases, of a new house or a existing house.

We expect the real estate lobby to argue vigorously against provisions.

John R. Mousseau, CFA
Executive Vice President & Director of Fixed Income
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