Romney Plan Giving State-Local Bondholders Anxiety: Muni Credit
Tax proposals from Republican presidential candidate Mitt Romney would help drive municipal yields to the highest level since March by ending the debt’s tax advantage at lower income levels, Morgan Stanley estimates.
Romney, who trailed President Barack Obama in some national polls this month, recommends ending federal taxes on interest, dividends and capital gains for those earning less than $200,000 annually. The shift would make issuers in the $3.7 trillion muni market compete on an equal footing with company and federal debt at those income levels, pushing up local yields.
If Romney, 65, also curbs munis’ exemption for wealthier investors, 10-year local yields would rise 0.49 percentage point to levels not seen in six months, Michael Zezas at Morgan Stanley wrote in a Sept. 4 report. The former Massachusetts governor hasn’t proposed that step, though he has called for lower tax rates and ending unspecified breaks.
“There is a blend of factors in Romney’s plan that potentially impact munis’ tax value in a negative way,” Zezas, Morgan Stanley’s head muni strategist in New York, said in an interview.
State and local debt tends to yield less than other fixed- income investments because of its tax-free income. Excluding interest on munis from federal taxation may cost the U.S. government $306 billion from 2013 to 2017, according to Morgan Stanley’s report.
Ending munis’ tax exemption was one suggestion in the Bowles-Simpson report released in 2010, which listed options for reducing the nation’s deficit.
Amanda Henneberg, a spokeswoman for Romney’s campaign, didn’t have an immediate comment when contacted via e-mail.
If investments such as corporate bonds were tax-free for some individuals, yields on munis would need to increase to attract buyers, said Clark Wagner, fixed-income director at First Investors Management Co. in New York, which handles $1.5 billion of municipals.
“It definitely would cause a sell-off in the municipal bond market,” Wagner said.
Taxpayers making less than $200,000 a year declared 51 percent of all tax-exempt income in 2009, according to Matt Fabian, managing director at Concord, Massachusetts-based Municipal Market Advisors. He cited Internal Revenue Service data. The 18-month recession that ended in 2009 pushed some earners below the $200,000 level, Fabian said.
Eliminating the tax advantage on munis would create “a potentially massive blow to aggregate municipal-bond demand,” Fabian wrote in a Sept. 4 report. Yields and prices move in the opposite direction.
“Muni bonds would have to compete,” Fabian said in an interview. “Muni prices would have to fall.”
If Romney were to also limit munis’ tax exemption for higher earners, yields on top-rated tax-frees due in 10 years would rise about 0.49 percentage point, to 2.28 percent by the end of 2012, Zezas wrote. That would be the highest level since March, Meghan Robson, an analyst at Morgan Stanley, said in an e-mail. The projection also assumes Treasury yields rise by year-end.
Benchmark munis due in 30 years yielded 2.89 percent Sept. 21, data compiled by Bloomberg show. For bondholders in the highest tax bracket, that’s equivalent to 4.45 percent. In comparison, 30-year corporates rated AA yield 3.72 percent, according to Moody’s Investors Service data. Treasuries of that maturity yielded about 2.94 percent on Sept. 21.
Proposals from Obama, 51, also include tax changes for muni investors, such as capping the value of itemized tax deductions at 28 percent, down from 35 percent. At the same time, he wants to raise the top tax rate on ordinary income to 39.6 percent from 35 percent. The proposal to put a ceiling on deductions hasn’t gained traction in Congress.
In trading last week, yields on benchmark tax-free debt due in 10 years were little changed at about 1.78 percent, according to a Bloomberg Valuation index. The interest rate set a record low of 1.63 percent in July.
A national poll conducted Sept. 12-16 by NBC News and the Wall Street Journal gave Obama a five-point lead among likely voters, 50 percent to 45 percent. Still, a Gallup poll covering the Sept. 14-20 period showed the candidates tied at 47 percent.
Potential yield increases for munis would lead localities to pay more when borrowing to help finance roads, public schools and water systems. States closed a cumulative $500 billion of budget deficits in the past four years.
“The proposals from both candidates are very different from the status quo,” Zezas said. “And therefore the election has a potential to be a catalyst for the market having to price in greater uncertainty around the tax status of munis, regardless of who wins.”
Following are pending sales:
PORT AUTHORITY OF NEW YORK & NEW JERSEY, which finances reconstruction of the World Trade Center site, plans to sell $2 billion of taxable revenue bonds as soon as this week, with maturities as long as 50 years, according to a preliminary notice of the sale. (Updated Sept. 24)
MASSACHUSETTS plans to issue $1.6 billion of general- obligation bonds via competitive sale as soon as this week, according to data compiled by Bloomberg. The debt will finance capital projects. (Updated Sept. 24)
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