Week of 05/10/2021

More Tax Audits Ahead, Yellen… Muni Rally Ahead… Chicago Pension Funds Outperform…Toll Roads Outlook Positive… Population Growth Drives Government Revenue…Taxable Muni Bonds’ Global Appeal…Puerto Rico Bonds Refuge From Biden Tax Hikes… Talks on $4 trillion Federal Spending…

More Tax Audits on Wealthy, Yellen… Treasury Secretary Janet Yellen is calling on the wealthy to pay their fair share of taxes and to close the tax gap, estimated to be $7 trillion over a decade, by improving tax compliance and audits. “We’re trying to make meaningful steps to close that gap.” The IRS could shrink the tax gap by around 15% in the next decade and generate over $1trillion in additional revenue by conducting more audits that specifically target those at the top per former Treasury Secretary Larry Summers. President Biden’s American Families Plan allocates $80 billion to the IRS for enforcement to raise between$700 billion and $1.4 trillion in revenue over 10 years by minimizing the tax gap. The increased revenue would come on top of raising taxes for corporations and wealthy individuals to make them “contribute their fair share,” per Treasury Secretary Yellen.

Muni Rally Ahead… Potential for an upcoming muni rally is front and center. Demand for tax-free bonds could accelerate in the summer months and pressures on tax-free bond supply could grow. During the summer months, investors will seek a large volume of tax-free bonds to reinvest about $150 billion of new cash received from municipal bond redemptions. Only about $125 billion new muni bonds could be issued this summer per Credit Sights and Municipal Market Analytics. Fewer tax-free muni bonds could be issued if lawmakers approve federal interest subsidies for states and local governments. As witnessed in2008, as and when federal interest subsidies are approved, states and locals are likely to issue more taxable bonds in place of tax-exempt bonds. “As the Fed quieted bears by holding stance and muni supply demand remains favorable, there is potential for a May rally” Bank of America strategists noted. Both Citigroup and Bank of America have echoed that a large pool of currently callable bonds could driven upcoming rally in municipal bonds. President Biden’s plans for higher taxes have accelerated demand for tax-free income provided by municipal bonds.

Chicago Pension Funds Outperform… Chicago’s four public pension funds delivered returns ranging from 10% and 15.5%, exceeding return assumptions. Governor Pritzker signed legislation over Mayor Lightfoot’s objections to raise cost of living adjustments for firefighter pensions that could cost Chicago up to $30 million annually. The Mayor has stressed commitment to protect reserves and end one-time debt refinancing tactics. Chicago CFO stated Chicago is fortunate to have received $1.9 billion federal relief, “which does buy us a longer bridge to our path in terms of mapping our path,” towards a 2023 target date for structural balance.

Toll Roads Outlook Positive… Toll road revenue and traffic is expected to grow faster than anticipated. Vehicle miles dropped 6%in 2020 from a year earlier. As many toll roads hiked toll rates post-COVID-19, toll road revenue growth will likely outpace traffic growth. Toll revenue will likely return to pre-COVID-19 level by 2022, with traffic returning to 2019 levels by 2024. In 2020, median debt service coverage for Moody’s rated toll roads is a solid 1.73x and median liquidity increased 25%. President Biden’s American Jobs Plan will shore up funding for roads, bridges and highways, but the planned funding is a fraction of the trillions of new capital needed to rehab the nation’s road network.

Population Growth Drives Government Revenue… Shifts in congressional representation influence funding. The census determines the number of House of Representatives members for each state, which can influence a state’s ability to land federal funding and other monies. While population grew across the West, California’s slower growth cost it a seat in Congress. California was one of seven states to lose a House member, while five states gained a seat and Texas gained two. United States population grew at the second-slowest growth rate for 2020 census period since 1800. Differences in population growth rate account for tax revenue variations across U.S. states. Faster population growth contributes to increases in personal income, a key driver of tax revenue in many states. On the flip side, higher population growth brings additional costs of affordable housing, infrastructure and education. An aging population will become a growing credit negative for more states over the next decade. Population growth trends contribute to government credit quality over the long term.

Taxable Muni Bonds’ Global Appeal… Along with yield advantage, taxable municipal bonds’ higher safety, credit quality and longer duration relative to comparable sovereign bonds entice foreign investors facing negative rates overseas. Taxable municipal benchmark yield of about 2.34% is about 76 basis points more than U.S. Treasury bonds and over 2 percentage points more than sovereign debt sold by Switzerland, Germany and the Netherlands. Foreigners hold $116 billion municipal bonds, 50% more than ten years ago. Revival of federal subsidies on bonds issued by states and locals could boost taxable municipal bond supply, while tax-exempt municipal bond issuance could dwindle.

Puerto Rico Bonds Refuge From Biden Tax Hikes… The appeal of triple-tax-exempt Puerto Rico bonds is set to grow against the backdrop of tax hike plans. The Island’s growing cash coffers and resurgent economy have not gone unnoticed. Puerto Rico had materially more cash than reported in its 2017 audit, Puerto Rico expert Cate Long added, “Unfortunately, the Puerto Rico government has slow walked their audited financial statements.” The Island’s attraction as a tax-shelter for wealthy individuals and hedge funds has grown leaps and bounds since President Biden announced a series of tax hikes on top earners. Lured by the Island’s tax incentives to attract wealthy mainlanders, a bevy of U.S. hedge funds have set up operations on the Island recently. That’s all good for Puerto Rico’s resurgent economy and its asset base rebuilt with unprecedented federal aid. With a looming Title III court hearing on July 13,where the court will consider the adequacy of the Disclosure Statement on the Island’s central government debt restructuring, Puerto Rico’s famed Title III bankruptcy could be in the rear view mirror this year.

Talks on $4 trillion Federal Spending…What would be the sticker price for federal spending and how could it be financed are raging topics in Congress. Mr. Biden said the weaker than expected jobs report released Friday made passage of his proposals more urgent. This week President Biden plans to meet with top congressional leaders and Republican senators to discuss the $2.3 trillion American Jobs Plan for infrastructure spending. House Speaker Nancy Pelosi has set July 4 as an informal date for passing infrastructure legislation in the House. Doubling the federal cap on private activity bonds is among steps lawmakers could take to finance infrastructure. Republican criticism of higher taxes and much of President Biden’s agenda means Democrats will likely resort to a budget maneuver called reconciliation to move the proposals through Congress. To begin the reconciliation process, Democrats first have to either approve a new budget resolution or possibly edit an existing one, steps that aides said could be weeks away.

Compare 30-Year taxable U.S. Treasury yield 2.28% to 30-Year tax-exempt muni bond yield “AAA” 1.60%; “AA”1.69%; “A” 1.96%; “BBB” 2.94%. For investors in the 35% tax-bracket, a 3% tax-exempt yield is equivalent to a 4.6% taxable yield. Top rated tax-free bonds yield70% of comparable taxable U.S. Treasuries.

Information obtained from sources deemed reliable; GMS does not purport Review/Preview contains all available information.