As the U.S. Presidential election draws nearer, many investors are eyeing the future of the soon-to-expire 2017 Tax Cuts and Jobs Act— a significant individual tax code overhaul that reduced taxes across income levels—and more specifically, it’s potential impacts to the municipal bond market. Although each possible election outcome will likely result in different tax scenarios, municipal bonds are set to maintain their tax-equivalent-yield advantage no matter the outcome.

Taxable equivalent yield (TEY) advantage of municipals at different tax rates
TEY by maturity

Taxable equivalent yield advantage of municipals versus Treasurys at different tax rates.

Source: Bloomberg, Principal Fixed Income. Data as of February 29, 2024.

The upcoming Presidential election is increasingly capturing the market’s attention. One of the most significant policy issues is the future of the 2017 Tax Cuts and Jobs Act (TCJA), an individual tax code overhaul that reduced taxes across income levels, set to phase out in 2025. Its sunset presents crucial fiscal decisions for the next administration, and each election outcome is likely to have implications on municipal bond markets:

  1. Divided Government: The TCJA likely expires, raising tax rates for all—notably, top earners with a hike to 40%. This would boost demand for tax-exempt municipals as exemptions become more valuable. The corporate tax rate would likely rise as well, increasing demand from taxable buyers (e.g., insurance companies).
  2. Democratic Sweep: Municipal demand would grow with expected increases in individual and corporate tax rates, aligning with President Biden's proposals for higher taxes on wealthy individuals and corporations.
  3. Republican Sweep: The status quo likely persists, with the TCJA's cuts extended, maintaining the top rate at 37% with minimal impact on tax-exempt municipal demand. On the taxable side, demand would remain low. Even at 37%, the TEY advantage that municipals offer is significant.

Regardless of the election outcome, the ever-increasing federal deficit underscores the importance of revenue, with individual income taxes remaining a primary source for the U.S. This is unlikely to change, and individual tax rates are unlikely to move lower. In fact, the opposite is more likely, further enhancing the value of the tax-exemption and leading to greater investor demand for the municipal asset class.

For additional insight into the key themes and investment implications across global fixed income markets, read our second quarter 2024 Fixed Income Perspectives.

Fixed income
Macro views

Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results and should not be relied upon to make an investment decision. Fixed‐income investment options are subject to interest rate risk, and their value will decline as interest rates rise. The market for municipal bonds may be less liquid than for other bonds. Income from municipal bonds may be subject to state and/or local taxes, and it may be subject to federal alternative minimum tax (AMT) for certain investors.

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