Washington – “Blue” states like Connecticut that fought against the Trump tax plan’s cap on state and local tax deductions are now seeing a silver lining – people turned to municipal bonds to lower their tax burden, which in turn lowered borrowing rates for state governments.
The new tax law capped the amount of state and local taxes, known as SALT, that taxpayers could deduct from their federal income tax at $10,000 this year. That drew howls of protests from “blue,” or Democratic-leaning, states whose taxpayers would more likely be hurt by the cap on deductions.
Connecticut joined a number of other states, including New York, California and New Jersey, to sue to block that change because their states have high costs of living, high incomes and high state and property taxes that, before the change, provided their residents with a valuable tax break.
But, having lost that tax break, there’s been a rush by taxpayers this year to replace it with municipal bonds which act as a tax shelter for income and can lower a person’s federal tax burden, and in some cases, their state and local tax burdens, too.
Connecticut was one state that benefited from the rush to buy municipal bonds, especially since it held its general obligation bond sale at the end of March, at the height of the tax season.
“Our bond sale benefited from a perfect storm of positive events and timing,” said Connecticut state Treasurer Shawn Wooden. “We hit the market at an advantageous time of low market interest rates and the impact that SALT had on individual investors seeking a tax shelter in bonds. SALT may well have been the catalyst for a record retail demand, with over $828 million in orders.”
Wooden said, however, that the record-setting order of $5.5 billion in bonds, more than five times the amount of bonds issued, “was greatly influenced by the message to investors that Connecticut is finally showing positive fiscal momentum on several fronts, and is serious about addressing the structural issues that have plagued us for decades.”
Increased demand results in lower interest rates states have to pay to bondholders. That means it cost less this year for Connecticut to raise money from its bond sale. Wooden estimated the savings at $45.8 million compared to the state’s last general obligation bond sale.
Bloomberg reported that most of the benefit of new interest in municipal bonds was centered in high-tax, Democratic controlled states, which received more favorable rates compared to local governments in low-tax, or “red” states.
Ken Flatto, the director of finance for the city of Bridgeport, said his city benefitted from a sharply increased interest in municipal bonds this year. The city held a bond sale of about $33 million in February and Flatto said “there was one of the highest demands in a decade.”
“It was four times the volume of the bonds,” Flatto said.”Which was really surprising.”
According to Morningstar data, municipal bonds saw more than $8.8 billion in net flows in the three months ended March 31, beating U.S. equity funds ($6.2 billion) and international equity funds ($1.3 billion).
Since the tax law went into effect in January 2018, municipal bonds have also outperformed both 10-year Treasuries and investment-grade corporate debt.
Michael Pietronico, chief executive officer at Miller Tabak Asset Management, said investors in three high-tax “blue” states — California, New York and New Jersey — experienced periods of chronic shortages of bonds to consider “as demand could almost be characterized as insatiable.”
Pietronico said that, unless there’s a change in tax policy, which he deemed unlikely, “one should assume that the demand for tax-free bonds will remain omnipresent.”