Tax Hikes Seen No Matter Who’s President, Making Muni Bonds Attractive

No matter who wins November’s US presidential election, there’s a growing risk that Americans will be paying higher taxes next year, according to MacKay Shields LLC. That makes muni bonds an attractive shield.

Thanks to higher interest rates, savers that piled a record amount of cash into money market funds and grew their earnings will be facing steeper tax bills. On top of that, key individual tax cuts are due to expire just as the US’s swelling deficit may prompt lawmakers to consider raising taxes, according to a mid-year report by the fixed-income boutique firm published Monday.

Buying municipal bonds offers investors — especially those in higher tax brackets — a way to cut their tax bill, since the income they generate is tax-exempt, according to the investment firm owned by New York Life Insurance Co.

“Because of the size of deficits and debt, the current tax regime is not generating enough revenue,” said Bob DiMella, executive managing director and co-head of MacKay Municipal Managers. “Even if there is a Republican sweep — taxes will at least hold where they are, or on the margin go up.”

President Joe Biden has vowed to raise taxes on businesses and high earners, while Donald Trump has campaigned on across-the-board tax cuts.

But DiMella said it would be extremely difficult for the economy to grow fast enough for the country to be able to pay off its debt. The prospect of higher taxes to address the debt combined with higher absolute rates will drive demand for munis next year, he said.

Meanwhile, some muni investors are growing more concerned about the future of the municipal bond exemption, given the increasing odds that Trump will be elected to a second term as President. DiMella said its elimination is unlikely.

Even if it were to happen, he added, policymakers would be inclined to grandfather in existing bonds, making them “substantially more valuable.”

For investors looking to tap into munis, MacKay suggests investing through a mutual fund, and says active portfolio positioning will help investors navigate the municipal yield curve, which has been inverted all year.

The asset manager is broadly optimistic about municipal credit, despite the potential of an economic slowdown, and pointed to municipal credit upgrades, which so far have outpaced downgrades by a ratio of 2.1 to 1.

Much of this year’s inflows have streamed into high-yield municipal bond funds, and year to date, higher yielding municipal debt had returned 4.8%. MacKay suggests investors adopt a mix of mix of 75% investment-grade and 25% high-yield munis in their portfolios.


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