The health care reform bill recently signed into law will have intended and unintended consequences throughout the municipal sector. While some provisions of the law begin shortly, many will not start for several years, including mandatory insurance in 2014. In addition, implementation will require further actions. For the municipal bond market, many of the results may be positive.
With new taxes imposed to pay for the program, one outcome is likely to be increased demand for tax-exempt municipal bonds and lower bond yields. With the overall cost for healthcare expected to rise, Federal spending will also grow and additional tax rate increases will be likely in the future. Municipal bond interest is exempt from the 3.8% tax surcharge on investment income for high-income investors which, combined with the sunset of the Bush tax cuts, will push the maximum tax rate on fully taxable income to 43.4%. In addition, it is likely that many non-profit hospitals will benefit from the increase in the proportion of Americans with insurance–through fewer write-offs on indigent patients, as well as possibly through fewer surplus beds and more insured procedures.
What does this mean for municipal investors? Higher tax rates mean a greater incentive to buy tax-frees, especially for high income individuals. For example, take a municipal bond with a yield of 3.80 percent. To a taxpayer in the 35 percent bracket, this is the equivalent of a 5.84 percent taxable bond (more if it’s a state specific bond). Under the probable new rules in 2013, the taxable equivalent yield on that same municipal bond will be 6.71 percent. Consequently, under the new reform, the municipal bond in this example is worth 15.7 percent more to the high bracket individual.