Wednesday, April 13, 2011

Tax exemptions for Munis in Jeopardy?

The Bond Buyer reports on congress looking into possibly doing away with the tax exemption on new Municipal Bond offerings. This is a risk that most will hush away as an impossibility. However Investment Mercenary favorite Jeffrey Gundlach hasn't nor have I. See: Gundlach: Two Ways to Lose in Munis

Senators Ron Wyden (D) & Dan Coats (R) introduced tax-reform legislation to eliminate the tax exemption. They would institute in its place a tax credit scheme to allow certain tax advantages with the bonds. If the budget deficits continue with no realistic plan this sacred cow for high tax states & investors could be in trouble. The budget problem is dire as I outlined in the post: Budget Crises Averted??? To fix the mess nothing will be safe when it comes to cutting or raising taxes.

Here are the consequences I see initially if this was ever to pass.
The Bad:
  • Municipalities would see their interest costs go up significantly
  • At this current time it would crater an already skittish market
  • Less benefit for wealthy individuals to fund municipalities
  • Municipalities would be forced to compete with other debt financing in the market place
The Good:
  • Municipalities would be forced to compete with all other debt financing creating a level playing field
  • Competition would force municipalities have the same stringent accounting as other bonds
  • Lower income investors would receive a much better yield that leads to a better tax benefit
My initial take would be that it in theory this could work as an overall benefit. What wouldn't, as it states in the article, is adding different tax rates and making our tax code more convoluted. As an aside I find it humorous that the politicians that are proposing this are the ones who's state's would have the most to benefit. Neither of their states have high personal income taxes. In fact Senator Wyden's state Oregon doesn't even have an income tax. Regardless don't right this or future legislation off that could effect muni tax-free interest.

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