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There is a new move afoot in Washington to limit the tax advantages of municipal bonds.

We have warned of this on several prior occasions over the past couple of years. While the probability of success of such efforts was low before the U.S. found itself it such a messy fiscal state, the chances of muni-bond holders "sharing the pain" and paying their "fair share" has risen substantially.

In today's Bloomberg, we find this:

Obama Proposes Limits on Tax-Breaks for Municipal-Bond Investors

Sept. 13 (Bloomberg) -- President Barack Obama proposed curbing the amount of interest from municipal bonds that top earners can exclude from their taxable income, a step that may diminish demand for state and local-government securities.

The president’s $447 billion job-creation plan would pare the tax break for municipal-bond interest to 28 percent for couples earning more than $250,000 a year. Such tax-exempt interest is currently worth 35 percent for earners in the top tax bracket …

The impact of such tax changes would probably be:

  1. market value of current muni-bond holdings would fall;
  2. the interest rate on new purchases to be higher to compensate for lost exemption;
  3. states and local municipalities would face higher costs of financing via tax exempt bonds; and
  4. the federal government would expand Build America bonds (taxable muni bonds) which further expands federal control over state and local decisions.

The article did not state how the President's proposal would impact property-casualty insurance companies. They are the second largest holders of municipal bonds after individuals.

If they also lost tax benefits, the effects of the tax change on the muni-bond market would be amplified.

Some short-term extra volatility might be introduced into insurance company stock prices while portfolios are adjusted, and as investors filter through company financials to ascertain the impact on a per company basis.

Disclosure: QVM does not have positions in any mentioned security as of the creation date of this article (September 13, 2011).


Source: Muni-Bond Tax Exemption At Risk In Obama Jobs Proposal