Why Munis Still Attract Investors
QUESTION: I am not a sophisticated investor. I don’t own any municipal bonds because I have always thought of them as investments only for very astute investors. But after reading story after story about how municipals offer one of the last tax breaks under tax reform, I’m starting to wonder whether I’m not missing out on a good opportunity. What still confuses me, though, is how to figure out when a higher taxable yield really leaves an investor with less money than a tax-free municipal bond at a lower advertised rate. I’m even more confused when I try to figure in the new, lower individual tax rates. Can you help me understand this without citing some complicated formula that someone as unsophisticated as I am can’t understand?--V. R.
ANSWER: There is nothing unsophisticated about your question. Even before President Reagan signed the tax reform bill into law earlier this month, dozens of readers were writing in to this column with virtually the same request.
First, a little background to help explain the sudden interest. Many investments that have been encouraged under U.S. tax laws for scores of years--most notably, corporate stocks--no longer will be tax-advantaged. All profits from stocks, for example, will be taxed under the new law--whereas only 40% of such profits are taxed now.
The idea is to create what politicians like to call a level playing field. That is, consumers should invest their money based on the worthiness of the investment itself and not on whether it’s a good deal from a tax standpoint.
No law is perfect, however. And this one is no exception. Municipal bonds, while their attractiveness was diluted somewhat by the reduction in individual tax rates, nevertheless were allowed to keep their tax-exempt status. Hence, the rush to buy munis.
In fairness to lawmakers, they did narrow the definition of municipal bonds for continued tax exemption purposes. For interest earnings from municipal bonds to be exempt from taxation under the new law, the project for which the bond is raising money must be a public project. Schools, libraries, highways, bridges and sewers are examples of such projects. Conversely, so-called private-purpose bonds--those issued for such projects as the construction of private hospitals, for example--lose their tax-exempt status under the new law.
The important date to remember here is Aug. 7, 1986. All bonds, regardless of their purpose, issued on or before that date retain their tax-exempt status. Only those issued after last Aug. 7 will be required to pass the public-private test.
Now, for your question. The charts below, prepared by the New York trade group, Public Securities Assn., show what a taxable investment would have to yield to match the spendable income you obtain from a tax-free municipal bond. They are divided into taxable income ranges for both single and joint returns and show what the tax brackets will be for the 1987 transitional year and 1988, when the new rates take full effect.
In 1987, the top tax rate will be 38.5%. And in 1988, the top rate will be 28%--except for those taxpayers who will be stung by an extra 5% surtax while certain personal exemptions are being phased out. For those consumers, the top tax rate actually will be 33%. 1987 Tax-Exempt/Taxable Yield Equivalents
Tax Bracket: 15% 28% 35% 38.5% Taxable Income Single $1,800- $16,801- $27,001- over Return: $16,800 $27,000 $54,000 $54,000 Joint $3,000- $28,001- $45,001- over Return: $28,000 $45,000 $90,000 $90,000
Tax-Exempt Yields Taxable Yield Equivalents 4.0% 4.7% 5.6% 6.2% 6.5% 6.0% 7.1% 8.3% 9.2% 9.8% 8.0% 9.4% 11.1% 12.3% 13.0% 9.0% 10.6% 12.5% 13.8% 14.6% 10.0% 11.8% 13.9% 15.4% 16.3%
1988 Tax-Exempt/Taxable Yield Equivalents
Tax Bracket: 15% 28% 33% Taxable Income Single $0- $17,851- $43,151- Return: $17,850 $43,150 $100,480 Joint $0- $29,751- $71,901- Return: $29,750 $71,900 $171,090
Tax-Exempt Yields Taxable Yield Equivalents 4.0% 4.7% 5.6% 6.0% 6.0% 7.1% 8.3% 9.0% 8.0% 9.4% 11.1% 11.9% 9.0% 10.6% 12.5% 13.4% 10.0% 11.8% 13.9% 14.9%
