Municipal bond yields offer attractive returns for individual investors. Could Congress kill their tax advantage?

CNN

05-05-2025

Many investors — especially high-income ones living in high-tax states — benefit from owning state and local municipal bonds for their tax advantages.
The interest investors make on munis is exempt from federal income tax — and in some cases, state and local taxes too, if you buy a muni issued by your home state.
The advantages of buying highly rated municipal bonds — which finance public works like building or improving roads, bridges and transit systems — have been particularly pronounced in the past month.
That's because muni bond yields soared due to a 'perfect storm' of events, according to Richard Saperstein, chief investment officer at Treasury Partners. There was the extreme market volatility that followed President Donald Trump's April 2 tariffs announcement. Investors sold municipal bonds to bolster their portfolios as stocks fell and also raise cash to pay their taxes. At the same time, a large number of municipalities were trying to attract funding.
While yields have since come down somewhat, they're still higher than they were before the tariff tumult. But they are likely to fall back to levels seen in the first few days of April, and then perhaps go lower still, said Tom Kozlik, head of public policy and municipal strategy at Hilltop Securities. 'In coming months, yields could fall further due to potential economic weakness and potential Fed action (to lower rates).'
But at the moment, Saperstein noted, investors still have a 'rare opportunity' to lock in a high rate of return now. 'Many high-quality municipal bonds are offering 4.5% yields, which is firmly above the 10-year Treasury rate.'
Another potential reason it may make sense to act sooner rather than later is because lawmakers may consider eliminating the federal income tax break on munis to help pay for the cost of making permanent many expiring tax provisions of the 2017 Tax Cuts and Jobs Act.
While the odds of their eliminating the muni tax break seem long — more on that in a minute — it is a possibility.
In a 'very preliminary' estimate, the Joint Committee on Taxation puts the price tag of extending expiring TCJA provisions at between $3.8 trillion to $5.5 trillion over just the first decade, depending on which provisions are included and whether interest costs on the additional debt that will need to be incurred are counted.
The muni tax break is not the most expensive on the books. An estimate from the House Ways and Means Committee put it at $250 billion over a decade.
But getting rid of it may lead to other costly outcomes. 'A repeal may lead to less investment in state and local infrastructure without another form of subsidy or transitional measures by the federal government,' according to a Tax Policy Center analysis. 'Alternatively, state and local governments would need to increase local taxes or cut spending to maintain infrastructure spending.'
There has already been pushback on the idea from some key Republicans. In an April 11 letter to Jason Smith, chair of the House tax-writing committee, House Financial Services Chairman French Hill and six of his GOP members urged Smith to support the preservation of the federal tax exemption.
'Municipal bonds have empowered nearly 50,000 state and local governments to finance schools, roads, water systems, hospitals, airports, and other essential public goods at lower cost to taxpayers,' they wrote. 'Any effort to eliminate or significantly curtail their tax-exempt status risks increasing borrowing costs, delaying or downsizing critical projects, and weakening the ability of local communities to respond to the unique needs of their residents.'
For Kozlik, the odds of a repeal depend on how much GOP lawmakers plan to cut to offset the cost of their mega tax and spending package, which is expected to include the extension of TCJA. For now, he puts the chances of a full repeal at 10%, but says the odds could run higher if lawmakers aim to come up with more than $2 trillion in savings.
At the moment, the number is $1.5 trillion, but it's still early days at the negotiating table.