Muni investors worried about tax impact from U.S. midterms

Reuters News
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Posted: Nov 05, 2014 7:27 PM

By Megan Davies

NEW YORK (Reuters) - Sweeping changes in the Senate have rekindled old worries for U.S. municipal bond investors about a clean-up of the tax code that could impact bonds, however, fundamental changes to the tax treatment of munis is seen unlikely.

Both Democrats and Republicans have talked about tax reform in the past, but having one party in control of Congress may increase the chance that something gets done, analysts say.

Tuesday's elections mean Republicans will take control of the 100-member Senate, enhancing their ability to push their own agenda and block Democratic President Barack Obama's initiatives in the last two years of his term.

"It's raised our awareness that maybe there is a chance that they can get some kind of tax reform at least on the table - at least more talk on it," said Peter Hayes, head of BlackRock's municipal bonds group. "Can they actually get it done? Still a longshot."

A team member of U.S. Senator Mitch McConnell, who is expected to become the Senate majority leader, said there could be an opportunity to do "meaningful things" to address the U.S. debt burden such as changes to the tax code.

Republican Dave Camp, head of the tax-writing House of Representatives Ways and Means Committee, earlier this year called for simplifying the tax code with proposals including taxing interest on municipal bonds for those with higher incomes. The proposal did not gain traction given gridlock in Washington.

Broad tax reform is seen by analysts as unlikely to be achieved in this administration as Obama still wields the veto pen.

There may be more weight, however, behind corporate tax reform due to the recent backlash against companies moving overseas to lower tax bills, analysts said. The Treasury announced regulations in September to crack down on these moves.

"Corporate tax reform would have some impact because there are plenty of corporations in the U.S. that are subject to paying taxes and as part of their investment portfolio buy municipal bonds," said Hayes, ahead of the elections. Lowering the rate could make munis less attractive and cause them to shed those exposures.

Bank of America analysts said in an Oct. 31 note that munis could face "collateral risk" if any corporate tax efforts are pushed, and components of Camp's bill "may be resurrected to curb costs associated with implementing corporate tax reforms."

Representative Paul Ryan of Wisconsin, a Republican, is expected to take over at Ways and Means.

Obama has also proposed measures that would affect munis, with budget proposals suggesting capping the value of the tax exemption for interest paid by munis.

Munis are prized for their tax-exempt nature and supporters say that allows states and cities to borrow cheaply. Previous tax reform efforts have affected munis, such as the Tax Reform Act of 1986.

(Reporting by Megan Davies; Editing by Bernard Orr)