On April 9, 2021, Sand Hill CIO Brenda Vingiello joined the CNBC Squawk Box program once again. With ramped up vaccine distribution and the U.S.read more
What a New Administration Could Mean for Municipal Bonds in 2021
Municipal bonds ended a volatile 2020 with broad market indices up more than 5% for the year. With a new incoming administration, we now set our sights on what potential changes lie ahead for the muni market. At roughly $4 trillion in size, the national muni market is a vital part of state and local finances, a popular investment for taxable investors, and an asset class that is often impacted by election outcomes..
Given that most investors turn to municipal bonds for their tax-exempt income, any changes to tax policy would likely directly impact the outlook for the asset class. With a very slim Democratic majority now in Congress, the consensus view is that taxes are likely biased higher for top income earners and corporations. Higher taxes tend to increase demand for municipal bonds, which would likely, in our view, drive bond prices higher. Other areas of the tax code that will likely be up for review are AMT income thresholds, the $10,000 cap on state and local tax deductions (SALT), and the prohibition on tax-exempt advance refunding bonds.
Before it was prohibited under the Tax Cut and Jobs Act of 2017, tax-exempt advance refunding was a common practice used by state and local governments to reduce borrowing costs by taking advantage of lower interest rates. You can think of this as being similar to how a homeowner refinances their mortgage after interest rates decline. In the current environment, we believe we could see a move to restore tax-exempt advance refunding bonds. This would be a credit positive for state and local governments as it would help reduce overall costs, and it would likely result in more tax-exempt issuance in the muni market.
While reviewing the tax code is on the agenda, the consensus view is that more economic stimulus will be the first priority. The most recently proposed economic stimulus package would provide $350 billion in aid to municipal governments. This would provide some welcome relief to local governments that did not receive any direct aid in the December stimulus bill. In terms of general credit conditions in the muni market, the initial impact of the pandemic has been uneven with higher default rates among hospitals, assisted living facilities and industrials. The extent of the damage thus far has also depended to some degree on how municipalities raise money. Communities that rely on tourist spending have done worse than those that rely on income taxes. Cities that rely on property taxes have fared better than cities that rely on sales tax revenue.
A policy issue that seems to have solid bipartisan support is infrastructure spending. The current proposal is for $2 trillion over the next four years to address infrastructure needs. While the devil is in the details, if the federal government launched a meaningful infrastructure package, this would be a positive development for the muni market. There is some government support for relaunching the ‘Build America Bond’ (BABs) Program, which began in 2009 as a response to the Great Recession. BABs reduced borrowing costs for state and local governments and rewarded bond holders with special tax credits. There has also been talk of additional aid for state and local governments dealing with climate change initiatives. A meaningful investment in infrastructure would certainly aid in the economic recovery by providing jobs and structural improvements to many communities in need.
As we think about what lies ahead for the municipal bond market, our outlook is favorable with strong investor demand, expectations of more fiscal stimulus, and an improving credit landscape. Municipal bonds should, in our view, continue to provide relative stability in the current environment and favorable after-tax income for investors in the year ahead.
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