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Supercommittee Countdown: Muni Bonds

As the supercommittee’s deadline approaches for reaching a deficit reduction deal, advisers and analysts say one possible casualty is the tax exemption for municipal bonds.

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The tax-free status of the bonds is regularly put on the chopping block as a way to improve the government’s finances. One previous proposal called for grandfathering in the tax exemption on existing bonds but making all new bonds taxable, while others have proposed removing the tax break completely. And in September, President Barack Obama proposed capping the tax break for high earners at 28%, from a current maximum of 35%. Eliminating the tax exempt status on state and local municipal bonds would save $161 billion in revenue through 2014, according to a report by the Congressional Research Service. But such a change would also raise borrowing costs for states and municipalities, which is one reason the exemption has been left alone. Nevertheless, advisers are pondering what steps to take should Congress choose to remove the tax break.

Laura Scharr-Bykowsky, a financial planner in Columbia, S.C., says she’s encouraging clients to buy individual municipal bonds instead of investing through a bond fund. If the tax exemption were eliminated on new bonds but grandfathered in for existing bonds, investors could see prices on those bonds shoot up as supply for tax-exempt bonds becomes limited, she says.  “You would now have a hot commodity,” says Scharr-Bykowsky.

However, there could be a selloff of municipal bonds if investors who rely on their tax-exempt status are forced to turn to other tax-saving strategies, says Anthony Valeri, a fixed income strategist with LPL Financial. Valeri says investors would have to move to short-maturity bonds which are easier to buy and sell than longer-term munis. But not all investors would flee the market, he says, since municipal bond yields would still be higher than other bonds, even without their tax exempt status. The average 10-year Triple A municipal bond is yielding 2.5%, compared with 2% for 10-year Treasury bonds, he points out.

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    • The mid terms empowered Republicans on promised spending and tax reductions. They are slowing Obama and Reid’s spending, and have successfully stopped tax increases. The transition of power is working as intended by the founding fathers. We need to send a clear message to DC to REDUCE the debt, not just slow the rate of increase.

    • The situation is hopeless. For many decades, due to FED’s easy money policy, Americans have borrowed and spent. This inflated the money supply, prices and salaries (inflation). But now borrowing has stopped. We ran out of borrowers. M3, which is broad definition of money supply, is deflating. With a deflating money supply it is not possible to pay the same salaries in the economy. For example, with money supply of 50 trillion, if avarage salary is 50K USD, when the money supply falls to 40trillion, average salary will have to fall to 40K. This is the reason why we have unemployment. State and local governments are going bust. Their programs, pension plans were built based on an inflated money supply. When deflation hits, states, local governments have to cut back spending drastically, or declare bankcruptcy. And where are the stocks?? Still up and running. Google for “financial mania continues” to understand the stock market bubble we have. Bonds are bubble, stocks are a bubble, debt is a bubble. Deflation is coming.

    • Question for Graveyard Whistler: Regarding your first post (Republicans SHORT the market …). I saw an identical response (comment #153) from a person named Maria Bartiromo to a NY Times op-ed, “As Deadline Nears, Deficit Panel Is Still at Deep Impasse,” dated Nov. 19th, 3:15 PM. Her response is a word-for-word copy of yours. Did “Maria” copy your response, or are you she?

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