With Municipal Bonds, Vote For Flexibility

It’s not uncommon for presidential candidates to take a shot at municipal tax exemption. This election is no different.

One of the candidates, Hillary Clinton, has proposed limiting the tax exemption of municipal bonds to 28 percent.

Well, if you’re in the top marginal tax bracket of 39.6 and you add on top of that the Medicare surcharge of 3.8, in essence you’re in a 43.4 percent top marginal tax rate.

Municipal Bonds
Image source: DonkeyHotey – Flickr
Municipal Bonds

If you limit municipal tax exemption to 28 percent, in effect, you’re creating a 15.4 percent tax, federal tax, on your municipal income.

But what would that really mean for the municipal market, if you were to limit tax exemption?

Well, the value of municipal bonds, initially, would fall. Not a lot. Bond portfolios are not going to be decimated when that happens, but what you want your bond manager to have, to insulate your portfolio, even from this risk that isn’t that great, is to have flexibility to maneuver. Maneuver, perhaps, into taxable bonds, such as Treasuries or investment-grade corporate bonds, because they clearly would not be impacted in such an environment.

So, having the ability to maneuver a part of your portfolio out of municipals into taxables, while this change is occurring, would allow the manager to protect the portfolio and insulate it, to a certain degree.

So, at the end of the day, tax exemption, or limiting tax exemption of municipal bonds, will have a somewhat negative impact. Not a huge impact, and it’s not going to decimate your portfolio. Just demand that your portfolio manager have the ability to navigate.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.