Since Republicans won control of both houses of Congress and the White House in last fall’s elections, investors have been anticipating the first major changes to the nation’s tax code in 30 years. The wait has ended with the recent release of the Tax Cuts and Jobs Act by the House Ways and Means Committee which provides a potential roadmap, although changes are likely as it will go through a lengthy and contentious legislative process. For municipal bond investors, the news so far is largely good as the proposed reforms contain some helpful provisions. Meanwhile, bond issuers face the possibility that the repeal of certain types of tax-exempt financings could limit their flexibility and increase borrowing costs.
A key concern for muni bond investors whenever Washington debates tax policy is whether the deductibility of municipal bond interest income will be reduced or eliminated. The current proposal preserves the tax exemption for municipal bond interest.
Another feature of the Republican tax proposal is a cut in the number of income tax brackets for individuals. The proposal keeps the top individual tax rate at its current 39.6% on incomes of more than $1 million while cutting the number of additional brackets in half from six to three. Despite that simplification, we expect the rates for individuals in the top three brackets to remain high enough that they will continue to seek the benefits offered by tax-exempt municipal bonds.