Per a request by Sen. Max Baucus (D-Mont.), the Congressional
Committee on Taxation released a report including
revenue-generating ideas earlier tin October. In that report was
a proposal that gained some attention earlier in 2012. That
proposal is the repeal of the interest deduction for municipal
bonds, a move that if it comes to pass could prove punitive for
municipal bond ETFs.
Despite a rising number of municipal defaults this year,
investors have
continued embracing muni bond ETFs
as one income-generating avenue. However, decent yields and
monthly dividends paid by ETFs such as the Market Vectors
High-Yield Muni ETF (NYSE:
HYD
) and the iShares S&P National AMT-Free Muni Bond ETF (NYSE:
MUB
) are only part of the allure of this asset class.
Another large part of the equation is the tax benefits. Since
the Sixteenth Amendment of the Constitution was adopted almost
100 years ago, the government has opted not to tax interest on
tax-exempt muni issues. Should the proposal to tax interest
earned on muni bonds become a reality, some analysts see problems
for municipalities and taxpayers alike.
"Rrepealing the interest exclusion of municipal bonds will
lead to higher financing costs for governments and, consequently,
local taxpayers,"
Jim Colby, senior portfolio manager at Market
Vectors
.
The proposal led to the creation of Municipal Bonds for
America, a group that is advocating for the proposal's repeal. If
the issue were getting more airtime, more investors would know
about Municipal Bonds for America. Perhaps the mainstream media
should do investors a favor and bring the group and its cause to
light more.
Approximately 70 percent of municipal bonds are owned by
individual investors,
according to Morgan Stanley
. That popularity is evident at the ETF level, too. The iShares
S&P National AMT-Free Municipal Bond Fund has almost $3.2
billion in assets under management. The Market Vectors High-Yield
Muni ETF has over $908 million in AUM and the Market Vectors Long
Municipal Index ETF (NYSE:
MLN
) has $106.2 million in assets.
Colby helps oversee nearly $1.9 billion in municipal bond
ETFs, including HYD, MLN and the Short Municipal Bond Index (NYSE
Arca: SMB).
"In my opinion, the practical aspect of this debate rests on
the reality that state and local governments must have access to
capital if they are truly to recover and rebound from the
recession,"
Colby wrote in a blog post
. "Municipals generally have long been an effective vehicle for
that access, and with rates remaining near historically low
levels, I see no better financing alternative."
The precarious financial positions of some states, California
among them, means the proposal to repeal the tax exemption for
muni bond interest payments has the potential to be a hot-button
issue. As Colby noted, neither President Obama nor Republican
challenger Mitt Romney want to be seen as favoring the idea.
In theory, if President Obama spook out in favor of the
proposal, the Romney camp could assail him for attacking a source
of income for retirees, a demographic that is among the largest
owners of municipal debt. If Romney advocated the proposal, the
President's team could frame it as another Romney flip-flop
because, to this point, the Republican has been opposed to tax
increases.
Another possible issue to consider is that if Uncle Sams
starts tax muni bond interest, some states could follow suit.
That could increase the allure of issues from states with no
income tax, but muni bond ETFs are not heavy on issues from
non-income tax states.
For example, Texas, Florida, Arizona and Nevada account for
barely more than 10 percent of HYD's weight, though Texas and
Florida combine for 11 percent of MUB's weight.
For more on muni bond ETFs, click
here
.
(c) 2012 Benzinga.com. Benzinga does not provide investment
advice. All rights reserved.