Taxes and Munis: Potential Post-Election Scenarios
The tax policies in place since 2018 face expiration and a wide-reaching revamp that could reshape the backdrop for municipal bonds.
Key Takeaways
Several Trump-era tax policies will expire in 2025, highlighting tax policy as a key consideration for voters before the November 5 election.
Key provisions from the presidential candidates will likely shape the relative attractiveness of tax-advantaged municipal bonds in 2025 and beyond.
With a more complex tax backdrop looming, we believe munis may offer an attractive source of tax-free income, diversification and risk management.
The sweeping Tax Cuts and Jobs Act (TCJA) of 2017 has been the nation’s prevailing tax policy for over six years. However, many of TCJA’s provisions expire next year, putting the spotlight on election-year tax policy proposals from Donald Trump and Kamala Harris.
Not surprisingly, their plans differ widely and have varying implications for municipal bond (muni) investors. Our muni team has examined critical components of the Trump and Harris tax frameworks to consider their potential impacts on the municipal bond market.
Impact of 2025 Tax Bill’s Sunset on Municipal Bonds
Signed into law by President Donald Trump on January 1, 2018, the TCJA included some of the biggest changes to the U.S. tax code in three decades. The reform affected individual taxpayers and businesses, particularly through the tax cuts slated to expire next year.
Extending these provisions may cost the federal government $3.5 trillion to $4 trillion in missed revenue over the coming decade. Without spending cuts or revenue enhancements elsewhere, deficits and debt would increase. Given these looming challenges, tax policy remains a key issue facing voters in this unprecedented election year. Specific provisions may have positive, negative or neutral effects on tax-advantaged munis, as this comparison table illustrates .
Post-Election Tax Policy Changes and Their Effects on Munis
Given the complexity of tax policy provisions and their revenue effects, we expect to see variations in the proposals we’ve outlined. Negotiations and trade-offs are likely, so the policies taxpayers ultimately face may differ from the plans the candidates are peddling today.
Income tax rates, capital gains tax treatment and SALT deductions are subject to congressional scrutiny and debate. Accordingly, the balance of power in Washington, D.C., next year remains a key factor driving federal tax policy.
AMT Will Likely Be a Contested Issue
We expect the complicated issue of personal AMT to be among the biggest tax-policy battles facing the new Congress. This tax places a floor on the percentage of taxes individual taxpayers must pay, regardless of how many deductions or credits they claim. It’s an alternative tax system that applies to high-income Americans who pay little or no taxes under the standard U.S. tax system.
The TCJA dramatically diminished the number of Americans subject to AMT by:
Increasing exemption amounts.
Raising the income level at which the exemption begins to phase out.
Repealing or scaling back some of the largest AMT preference items.
As a result, the number of taxpayers subject to AMT fell from more than 5 million in 2017 to just 200,000 in 2018, according to the Urban-Brookings Tax Policy Center.
The AMT's revenue-raising potential may capture Congress’s attention. In 2023, the tax accounted for approximately $6.7 billion, or 0.3% of all individual income tax revenue. That was down significantly from 2017 when the tax generated $38.3 billion, or 2.5% of income tax revenue.
AMT revenue will likely soar when most TCJA individual income tax provisions expire at the end of 2025. Our analysts predict reverting to pre-TCJA AMT rules would generate $102.1 billion by 2032, or 3.06% of all individual income tax revenue.
In general, higher marginal taxes for individuals or corporations would increase the attractiveness of tax-free municipal-bond income. Conversely, lower tax rates or tax liabilities would likely have a negative effect on muni demand.
Managing Taxable Income Exposure and Diversification with Munis
Regardless of the November 5 election outcome, income taxes remain one of life’s two certainties, as Benjamin Franklin cleverly professed 235 years ago. As such, we believe it’s important to remember the distinctive qualities of municipal bonds:
They remain among the few easily accessible tax-advantaged investments available today.
Munis generate income free from federal taxes and sometimes state and local taxes.1
Investors in the highest income tax brackets typically benefit most from munis, but the tax advantages aren’t exclusive to the wealthy.
Along with tax benefits, we believe munis can add diversification to stock- and bond-heavy portfolios. The asset class tends to react to economic and market movements differently than other securities, potentially enhancing performance potential while managing risk.
Authors
Senior Portfolio Manager
Senior Director, Product Management
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1 Investment income may be subject to certain state and local taxes and, depending on your tax status, the federal alternative minimum tax (AMT). Capital gains are not exempt from state and federal income tax.
Even though a tax-free bond fund is designed to purchase assets exempt from federal taxes, there is no guarantee that all of the fund’s income will be exempt from federal income tax or the federal alternative minimum tax (AMT). Fund managers may invest assets in debt securities with interest payments that are subject to federal income tax and/or federal AMT. State and local taxes may also apply.
Diversification does not assure a profit nor does it protect against loss of principal.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Generally, as interest rates rise, the value of the bonds held in the fund will decline. The opposite is true when interest rates decline.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.