ganns@hound.UUCP (R.GANNS) (02/25/86)
I have heard that, depending upon how the new tax laws turn out,
that there could be a steep drop in price for tax exempt municipal
bonds in the not too distant future.
Does anyone have any astute insights into this?ka@hropus.UUCP (Kenneth Almquist) (02/27/86)
> I have heard that, depending upon how the new tax laws turn out, > that there could be a steep drop in price for tax exempt municipal > bonds in the not too distant future. My guess (NOT guarenteed!) is that this will not happen. I predict that prices will continue to rise even if tax reform passes. The reason that tax reform could decrease the price of municipal bonds is that decreasing the marginal tax rate decreases the value of the tax exemption that these bonds enjoy. Currently the top marginal tax rate is 50%. To someone in this tax bracket, 8% tax free is equivalent to getting 16% on a taxable taxable. If the top marginal tax rate is de- creased to 35%, then this person would have to purchase a 10.4% tax exempt bond to get the same 16% equivalent taxable return. Therefore, if the marginal tax rate is decreased, investors may be expected to demand higher interest rates on tax exempt bonds, which will decrease the price of existing bonds. There are several reasons why this decrease may not occur. First, the tax bill places limits on the uses to which the proceeds of tax exempt bonds may be put. The result is that there was a huge flood of new issues at the end of 1985 in order to beat the deadline, which depres- sed prices (although I believe that prices have recovered to a large degree since then. Second, these limits will decrease the supply of tax exempt bonds in the future, which should tend to increase the price. Third, the tax bill will increase the number of people in the top tax bracket (unless we get an additional 40% tax bracket). This will result in there being more potential buyers of tax exempt bonds, which should also tend to increase prices. Fourth, the tax exempt bond market already knows about the tax bill, with the result that the possibility of lower marginal tax rates is factored into the current price of the bonds. Finally, interest rates keep on falling the prices of all bonds should rise even if the prices of tax exempt bonds do not rise as fast as those of taxable bonds. In general, if you buy a tax exempt bond, you should plan to hold it for a long time because trading tax exempt bonds is expensive. Compare the before tax return of tax exempt bonds with treasury bonds and with AAA rated corporate bonds. The effective rate on the tax exempt bonds should be higher that than the rate on the treasury bonds because treasury bonds are noncallable. The rate should also beat the rate on corporate bonds to compensate you for the lower liquidity of tax exempt bonds. If the tax exempt bonds can beat the effective rate of return on the other bonds even when you calculate your marginal tax rate based upon the House tax reform bill, buy tax exempt bonds as long term investments and don't worry about which way the value of your investment goes over the short term. It is easy to be wrong about which way bond prices will go; the advantage of bonds is that the return to maturity is guarenteed. Kenneth Almquist ihnp4!houxm!hropus!ka (official name) ihnp4!opus!ka (shorter path)
ekrell@ucla-cs.UUCP (02/28/86)
the only municipal bonds affected by the new legislation, if any, will be
the ones issued in 1986. The legislation is supposed to have stricter
qualification rules to grant tax exemption status on the bond.
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Eduardo Krell UCLA Computer Science Department
ekrell@ucla-locus.arpa ..!{sdcrdcf,ihnp4,trwspp,ucbvax}!ucla-cs!ekrellmazlack@ernie.berkeley.edu.BERKELEY.EDU (Lawrence J. &) (03/01/86)
> I have heard that, depending upon how the new tax laws turn out, > that there could be a steep drop in price for tax exempt municipal > bonds in the not too distant future. > Does anyone have any astute insights into this? Existing bonds would probably be grandfathered, so their value would not change unless the tax brackets also do (also part of the proposal). New bonds, would be affected tho. ...Larry Mazlack