Taxable Municipal Bonds grabbed the attention of not only municipal bond market participants in 2020, but also of investors and financial professionals globally across the asset class landscape.
Nationally, new issue volume growth was confined to the burgeoning taxable municipal bond sector, where issuance doubled from $72.2 billion in 2019 to $145.2 billion in 2020. By comparison, tax-exempt issuance in the municipal bond market declined slightly from $354 billion to $328 billion.
The eye-popping issuance figures for taxable municipal securities made headlines throughout the year. The $145 billion of new taxable municipal bonds were issued as fully Federally taxable, but in most cases, retained the applicable state tax exemption. This accounted for almost one third of all municipal bonds issued and ultimately accounted for the entire increase in total issuance in 2020. The prominent rise of this mechanism in the municipal market occurred as a consequence of the component of the 2017 Tax Cuts and Jobs Act which eliminated tax-exempt advance refunding of tax-exempt issues.
Questioning The Tax Exemption – Again
With taxable municipals accounting for such a prominent slice of state and local government borrowing there has been growing speculation in the financial press, and among market participants, about what this means for traditional tax-exempt financing. Common viewpoints gaining traction have called into question the need for traditional tax-exemption in municipal finance and even suggested the success of taxable issuance in 2020 proves municipal bonds can exist without the tax-exemption.
This speculation has been fueled by a number of misperceptions about the municipal bond market and the nature of public finance. The explosion in taxable issuance ultimately resulted from the confluence of two watershed developments:
• The arbitrary prohibition of the advance refunding mechanism that had been a staple of municipal finance for 100 years.
• Generational lows in benchmark U.S. Treasury yields off of which the yields of other taxable securities are “spread” by a variety of taxable investors.
What these developments ultimately point to is the simple continuation of the old fashioned resourcefulness of the nation’s municipal finance officials: optimizing the borrowing costs of their taxpayers and constituents, rather than a long-run steady state “transformation” of the municipal bond market.
Tax Cuts and Jobs Act – Where It All Began
The 2017 Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017. It was hailed as significant tax reform, primarily for its reduction in marginal individual income tax rates, although its “significance” seems muted compared to the 1986 Reagan-style tax reform that dropped top rates from 50% to 28%. Of greater impact to the municipal market was its provision that prohibited the advance refunding of tax-exempt securities with proceeds from tax-exempt issues.
Read more “Taxable Municipals – Myths and Misperceptions”