Appetite for `muni' bonds is keen in light of proposed tax reforms
Step by step, Congress seems to be moving closer to writing some sort of tax reform legislation, possibly by early next year. And with each step, people who invest in municipal bonds are calculating the gains they would make should they buy before some of President Reagan's proposals are approved and take effect. Thanks partly to the uncertainty over changes in the tax laws, municipal bonds have once again set a record for sales. At the same time, yields on ``munis'' are as high as they have been in many years, compared with taxable investments.
By last week, more than $103 billion of new municipal bonds had been brought to market this year, surpassing the $101.88 billion sold in all of 1984, another record year, according to a spokeswoman for John Nuveen & Co., a Chicago municipal bond investment firm.
This torrid pace could get even hotter if anything like President Reagan's proposal to tax the interest income from most municipal bonds appears to be getting through Congress, bond analysts say. Even if Congress doesn't go along, there will still be plenty of paper available at good rates.
Cities, states, and other government agencies that issue municipal bonds waited a long time for interest rates to get as low as they were likely to go before issuing new bonds. When that level appeared to be reached this year, these financing mechanisms for roads, bridges, schools, hospitals, housing, fire stations, and sewers finally came to market.
Also, cities and towns that had to obtain financing a few years ago at 12 to 13 percent have come back to the market with refunding bonds, further adding to the supply.
As a result, yields have remained relatively high, despite the general decline in interest rates.
``This is a pretty good time to be buying municipal bonds,'' says Richard Ciccorone, a vice-president at Van Kampen Merritt Inc., a brokerage. At present, he says, municipal bonds are paying more than 85 percent of the rate offered on 30-year Treasury bills, the taxable investment whose yield is most often compared with tax-free municipals. In the past, a 60 to 70 percent ratio was more common, he noted.
With these high yields, the Nuveen spokeswoman points out, municipal bonds begin to make sense to an investor in the 33 percent bracket, that is, with an adjusted gross income of $36,630 on a joint return -- not a big deal for today's growing number of two-earner families. A 9 percent yield in that bracket would be equivalent to a 13.3 percent taxable yield. On a single return, an adjusted gross income of $29,970 is sufficient.
Residents of states with a high state income tax would do even better. In California, for instance, where the top state tax rate is 11 percent, a taxpayer in the 50 percent federal bracket would find that a municipal bond paying a 10 percent tax-exempt yield would be equivalent to a taxable bond paying 18.5 percent.
Under the President's second tax reform proposal, known as Treasury II, about 80 percent of all municipal bonds would be subject to federal tax. This includes student loan bonds, hospital bonds, and the whole variety of industrial development bonds, such as those used to finance sewer disposal and pollution control systems and multifamily housing. These are also known as ``private purpose'' bonds, which the administration defines as issues where more than 1 percent of the proceeds are raised for nonpubl ic proceeds, including hospitals and industrial parks.
The only tax-free exception would be revenue and general-obligation bonds used for ``traditional'' purposes, as defined by the Treasury Department. Before it is through, Congress may lengthen the list of exceptions somewhat, but a tax on at least some municipal bond income is expected to be approved.
For purchasers of private-purpose bonds, particularly those bought before a new tax takes effect, the market price on their investments would probably increase. This is because the earnings on these bonds would keep their tax exemption.
Something else causing uncertainty for municipal bonds is the possibility of a reduction in the top tax rate from 50 to 35 percent. For now, this is not likely to have much effect. A lower rate would be more likely to hurt tax shelters and other limited-partnership syndications, leaving municipal bonds, bond funds, and unit investment trusts (UITs) a bigger share of the pie. Looking back, when the top tax rate was cut from 70 to 50 percent beginning in 1982, there was no decline in municipal bond sal es.
As with all investments, diversification in municipal bonds is probably the best protection. Now, many investors are finding more protection with insurance. As of this year, for example, insured municipal UITs, or MUITs, account for more than half of total UIT volume. There are now about a dozen sponsors of insured municipal UITs, including Van Kampen Merritt, John Nuveen, Clayton Brown & Associates of Chicago, Salomon Brothers, Kemper Financial Services, and Kidder, Peabody. Minimums range from $1,000
to $5,000.
For $1,000 in most cases (and sometimes less), you can also go with mutual funds that invest in municipal bonds. Like MUITs, these come in insured and uninsured varieties. In a MUIT, the bonds are generally held in the portfolio until they mature. In a mutual fund, bonds are continually being bought and sold.
Insurance will cost you a little, however. Most insured MUITs pay from 0.2 to 0.6 percent less than uninsured MUITs holding the same quality bonds. But for many investors, that may be worth it for fewer worries.
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