President Biden’s recently proposed $2 trillion infrastructure investment plan would, if enacted as-is—a big “if” for sure— provide much needed support to traditional infrastructure projects like roads and bridges amongst other projects. While the plan would tangentially support the municipal market through better economic growth and higher tax revenues, there could be other provisions that would impact the municipal market more directly. Three provisions in particular stand out to us as being supportive of current municipal market valuations:
- Higher income taxes: Along with higher corporate income taxes and higher capital gains taxes, Biden also campaigned on higher income taxes for the top income earners in the country. During the campaign, he proposed raising the top individual income tax rate to 39.6% from its current level of 37%. If enacted, and as seen in the LPL Chart of the Day, the tax-equivalent-yield (TEY) of municipal securities would surely benefit but given current valuations, most of the benefit would be seen at the longer end of the yield curve. Nonetheless, an increase in taxes generally increases the attractiveness of tax-exempt securities.
- An increase in federally subsidized issuance: Similar to the taxable Obama-era Build America Bonds, which provided direct federal support to interest payments, there is a growing chorus for another program that allows municipalities to issue taxable debt that would be partially funded through direct federal subsidies. An increase in taxable issuance would impact tax-exempt issuance likely causing an otherwise shortage of traditional tax-exempt municipal securities.
- Flexibility around refinancing: As part of the 2017 Tax Cuts & Jobs Act, certain municipalities were prevented from retiring existing debt by issuing new debt—a practice called advanced refunding. Clever municipalities found a workaround for this limitation by issuing taxable debt as Treasury yields were at multi-generational lows. As Treasury yields move higher, taxable issuance becomes cost-prohibitive. Discussions are underway currently to eliminate that restriction, which gives municipalities (munis) cheaper ways of refinancing existing debt.
“Munis are one of the bright spots for fixed income investors this year, but there are a number of good reasons for that. The likelihood of higher individual taxes, most notably, have made munis fairly attractive” according to LPL Fixed Income Strategist Lawrence Gillum.
To be sure, these provisions are yet to be fully enacted or even approved as the bills are still being discussed in Congress. Nonetheless, the expectations of higher taxes in particular have caused certain investors to move pre-emptively into the municipal market. According to Lipper, which tracks investor flows into mutual funds, municipal bond funds have seen inflows in 48 of the past 49 weeks, totaling $101 billion. This has caused benchmark municipal yields to decrease to multi-year lows. However, with the financial support provided to many municipalities as part of the American Rescue Plan coupled with the technical support described above, the municipal market is likely to continue to warrant higher valuations.
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