One thing is unlikely to change as Republicans take control of Congress: the century-old tax break for investors in the $3.6 trillion municipal-bond market.
With the U.S. budget deficit shrinking and President Barack Obama in office through 2016, analysts see little chance of a broad tax-code overhaul that could reduce the subsidies given to state and local government bonds.
The prospect of taxing muni-bond interest has been raised since 2010 as Obama and congressional Republicans looked to lower the deficit or pay for cuts to income-tax rates. Such a change would reduce the value of munis, which command higher prices than other securities because the interest has been exempt from the federal income tax since its creation in 1913.
“As for the risk of a near-term tax reform, it’s very minimal,” said Mikhail Foux, a municipal-market analyst with Citigroup in New York. “We’re unlikely to see anything before the next presidential election.”
In November, Obama said he wants to reach an agreement with the new Congress to revamp the tax code. While Republicans will control both the House of Representatives and the Senate, they still don’t have enough power to override a veto by the Democratic president.
U.S. Rep. Paul Ryan, R-Wisconsin, the next chairman of the tax-writing House Ways and Means Committee, has said that focusing on business taxes may represent the best chance for success, given how far apart Obama and Republicans are over how to approach taxes on individuals.
That approach lessens the odds that Congress may alter the status of municipal bonds, most of which are held by individuals seeking tax-free income, said Dustin McDonald, lobbyist for the Government Finance Officers Association.
The tax break, forecast to cost the Treasury about $47 billion this year in foregone revenue, has been targeted along with dozens of other provisions in overhauls that failed to advance during the past four years.
In 2010, Obama’s deficit-cutting commission proposed taxing munis to lower rates and increase revenue. Obama and Republican Rep. Dave Camp, the departing head of Ways and Means, endorsed taxing some interest income received by the highest-earning households.
The failure of the plans was welcomed by investors and state and local government officials, who said that changing the tax status of municipal bonds would depress prices because buyers would demand higher yields to offset the cost. On Dec. 31, benchmark 10-year munis yielded 2.11 percent, about 0.07 percentage points less than Treasury bonds, a reflection of the tax advantages.
