How might tax reform impact
tax-exempt bonds?

Mar 27, 2017
By BlackRock

Munis may feel an impact, but will retain some tax benefit, says Peter Hayes, Head of the BlackRock Municipal Bonds Group.

Talk of sweeping tax reform has led to speculation about what changes could mean for municipal bonds. The two areas of focus: A reduction in individual and corporate tax rates, and the elimination or capping of muni tax exemption.

A cut in individual tax rates would reduce the value of a municipal bond’s tax exemption, though Peter Hayes, Head of the BlackRock Municipal Bonds Group, does not see that change coming soon as Washington focuses on the “comparatively easier task of corporate tax reform.”

Current proposals would see the high tax rate fall from 43.4% to 33%. Mr. Hayes notes that the market has weathered similar changes before, and that investors would continue to reap an after-tax benefit under current conditions.

Mr. Hayes says the tax-exemption of muni bond income may be “alterable, but not dispensable.” In other words, he does not see tax-exemption being eliminated, though a 28% cap is not impossible. Much like the change in tax rates, however, his team estimates the market would prevail without a material change to the overall demand dynamic.

Munis offer a yield advantage, even at lower tax rates
Yields before and after tax

Munis offer a yield advantage, even at lower tax rates

Sources: BlackRock and Bloomberg; as of Feb. 7, 2017. Muni yields from Municipal Market Data (MMD). Current Muni Yield is before tax. TEY (or tax equivalent yield) figures show the yield offered by the municipal bond after factoring in a high tax rate of 43.4% and proposed new high tax rate of 33%.

Corporate tax reform adds another wrinkle to the equation, potentially offsetting some of the above impacts. Ultimately, “tax reform” is a series of possible scenarios featuring many variables and intervening factors. But Mr. Hayes offers this solace: “Munis will retain some tax-exempt benefit — and there will always be an appetite for that very unique feature in an investment asset.”