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The Top Three: The New Administration’s Impact on the Municipal Market

How will the new administration impact the municipal market? Here are the top three takeaways from our conversation with Baird’s Bryan Derdenger, Managing Director, Municipal Underwriter.

1. Divided government will require legislative compromise.

A divided government allows for collaboration and bipartisanship among political parties, which is essential to ensure policies address the needs of the masses and cover significant issues. Treasury yields rose post-election reflecting concern about one-party control under the assumption that the new administration would not have much opposition. However, the recent reelection of House Speaker Mike Johnson, who received the exact number of votes needed to win, illustrates the narrow margins in the House of Representatives. Similarly, the Senate also has close margins.  This will influence future policy creation as compromise will be required.

2. The Administration’s reconciliation bill has pros and cons for Muni market impacts.

President Trump plans to pass one large reconciliation bill within the first 100 days in office to address key priorities including the Tax Cuts and Jobs Act, which is set to expire in 2025, but could be extended or become permanent as well as expanded.

As part of the 2017 tax bill, the state and local tax (SALT) deduction was capped at $10,000, but with the set expiration at the end of 2025 and President Trump’s goal to lower taxes, the administration may reinstate the SALT deduction by either doubling the current amount or eliminated the deduction cap all together. Bringing back SALT would negatively impact municipal spreads and ratios as taxpayers would pay less in federal taxes, and there would be a reduced need for the municipal exemption. However, reinstating SALT would increase opportunities for municipalities to pass new referendums and financings. If taxpayers pay less in federal taxes after being able to deduct more or all of their real estate taxes from Adjusted Gross Income, they could be more open to new local taxes unless inflation kicks in further.

Additionally, President Trump’s stance on Tariffs is well known, although the use remains uncertain. The impacts to the municipal market as well as the broader Fixed Income market will depend on the policy’s implementation and scope.

We expect a few other impacts from the election that may balance the significant fiscal effects associated with the possibility of reinstating the SALT deduction and/or extending and expanding the Tax Cuts and Jobs Act.

  • Municipal Exemption: While there was initial speculation that the municipal exemption could be cut, it seems unlikely.  Repealing the municipal exemption would result in a direct tax increase for the American people. The plan to reduce income and corporate income taxes would decrease demand for the municipal exemption. After the Tax Cuts and Jobs Act was enacted in 2018, the market adapted well, finding new buyers to replace the insurance companies and larger corporations that moved away from the municipal exemption as they did not need it due to low rates.
  • Higher Education Taxation: Members of the House of Representatives and the prior Trump Administration have proposed making the endowments of higher education institutions taxable rather than tax-free. These institutions receive billions of dollars in endowments yearly, and imposing taxes on them could significantly help to offset the cost of reinstating the SALT deduction.

3. Uncertainty for the Municipal Market will continue near term.

Until all of the new Administration’s positions are filled, it will be challenging to make any specific forecasts or predict long-term effects on the municipal market. In the meantime, issuers should work with their municipal underwriters to manage their calendar and monitor economic data and potential policy impacts to take advantage of favorable conditions.