Tags: muni | bond | tax | exemption

Bond Dealers’ Nicholas: Congress Might Limit Muni-Bond Tax Deductions

By Michael Kling   |   Wednesday, 21 Nov 2012 11:12 AM

Should you say goodbye to the municipal-bond tax exemption?

Congress might limit how much income muni-bond investors can deduct as part of a budget deal, delivering a blow to both municipalities and investors.

Limiting the popular tax deduction might increase borrowing costs for state and local governments, which could cause local sewer and water authorities to increase their customers' water and sewer rates.

Editor's Note: The Truth About the Economy — Government Documents Lead to Eerie Conclusion

“If munis are taxable, their cost of finance goes up pretty significantly,” Mike Nicholas, CEO of the Bond Dealers of America, told CNBC. “It’s simply that the product is less attractive to investors.

“This is not just a tax on wealthy investors, it’s a tax on everyone.”

Filled with uncertainty, investors are already concerned about tax rates on capital gains and dividends increasing.

Congress is not expected to completely eliminate the muni-bond tax deduction, although it might cap the tax deduction, according to CNBC.

Still, experts say the muni-bond tax exemption has never been so threatened.

“The conventional wisdom states that we won’t have to worry about the tax-exempt status of muni bonds until full-blown tax-reform efforts," Nicholas told CNBC.

"However, there is a very real possibility that near-term efforts to address the fiscal cliff could include a cap on the amount of deductions that would threaten the tax-exempt status of munis.”

“The bottom line is there’s plenty of talk because everything about the fiscal cliff is about finding revenue sources, and the thinking is it’s a benign source,” John Donovan, head of municipal bond trading at Cantor Fitzgerald, told CNBC. “There’s been all sorts of talk and rumors.”

Many states and towns in the Northeast, heavily damaged by Hurricane Sandy, will need muni bonds to rebuild. That factor, CNBC noted, could counteract the argument for limiting the tax exemption.

A partial tax exemption, such as deduction limits for taxpayers in higher income brackets, will create confusion and possibly impinge the muni-bond liquidity, according to Investment News.

Most ordinary investors, "Mr. and Mrs. Main Street," may have trouble understanding the new rules and valuing muni bonds, Stephen Winterstein, a fixed-income strategist at Wilmington Trust, told Investment News.

Most people, he said, don't even know what tax bracket they're in.

Editor's Note: The Truth About the Economy — Government Documents Lead to Eerie Conclusion

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