Talk Of Flat Tax In Congress Leveling Muni Bond Market

Proposals to simplify the U.S. tax system have been complicating life for investors in municipal bonds and municipal bond funds.

While prices of most other types of bonds have rallied sharply in recent weeks, securities of state and local governments have hardly moved at all.

The problem arises from the exemption that municipals enjoy from federal income tax on the interest they pay.

This feature, normally considered one of municipal bonds’ biggest virtues, has suddenly become a detriment as investors contemplate the possibility of a new tax system in which all investment income from any source might be shielded from taxation.

Were such a change to happen, it would stand to neutralize munis’ tax advantage, and thus force their prices down (and their yields upward) to levels comparable with taxable bonds issued by corporations and other entities.

In fact, analysts say, bonds of many municipal issuers would probably have to sell for less, and yield more, than typical corporate bonds because most municipalities lack the financial clout and visibility that a good many corporations command.

So, the way many observers see it, the tax-reform “scare” has created some bargain-hunting opportunities for municipal bond investors.

But it is also apparent that anyone who buys now needs to be prepared to face more of the same negative psychology in the weeks and maybe months ahead.