The municipal bond market could experience a "significant effect" as a result of the election, according to an analyst's prediction.

• The municipal bond market could be affected by the election outcome and future policy, experts predict.
• Muni bonds are a popular investment choice for higher earners as they generate federally tax-free interest and avoid state taxes when investors reside in the issuing state.
• There is uncertainty about interest rates, income taxes, and public financing.

As the Federal Reserve considers cutting interest rates, municipal bonds may experience increased demand, according to experts. However, several factors must be closely monitored, including the results of the presidential and congressional elections, as well as any future policies that may be implemented.

Muni bonds are a popular investment option for higher earners as they generate federally tax-free interest and avoid state taxes when investors reside in the issuing state. Additionally, muni bonds typically have lower default risk compared to their corporate counterparts.

The election's outcome could significantly affect the future of the U.S. municipal bond market, according to Tom Kozlik, head of public policy and municipal strategy at HilltopSecurities. Changes in future policies from the next president and Congress, such as tax modifications or public financing, could make munis more or less appealing to investors.

Rewritten: * "How on-time rent payments can help 'credit invisible' consumers be seen" * "Lower capital gains tax, SNAP cuts: What Project 2025 could mean for your wallet" * "Here's where 2024 vice presidential picks stand on Social Security"

How muni bonds have fared for investors

Despite losses in 2022 and 2023, muni bonds have been slightly positive in 2024, with a 1% year-to-date return for the S&P municipal bond index, as of July 17.

VLP Financial Advisors' director of investments, Sean Beznicki, stated that muni yields are currently at their highest levels in years, providing significantly better compensation compared to recent history.

When the Fed cuts interest rates and demand increases for muni bonds, yields could fall quickly, said Kozlik. Bond prices and yields move in opposite directions.

To make a fair comparison between municipal and corporate bonds, it is necessary to consider after-tax yields.

If you're in the 35% tax bracket, comparing an 8% corporate bond to a 5.25% muni bond, you would receive 5.2% after federal taxes.

The lower your income, the less tax benefit you'll receive from municipal bonds.

The decision to buy or sell muni bonds ultimately depends on your individual circumstances, such as goals, risk tolerance, and timeline, according to Beznicki.

Tax uncertainty for muni bonds

If Congress does not act, taxes will increase for most Americans after 2025 due to the expiration of trillions in tax cuts.

The Tax Cuts and Jobs Act of 2017 reduced the federal income tax brackets, with the top rate decreasing from 39.6% to 37%. Additionally, the $10,000 federal tax deduction for state and local taxes, commonly known as the SALT deduction, will expire after 2025.

Both former President Donald Trump and President Joe Biden have different views on extending tax cuts from the TCJA. While Trump wants to fully extend the cuts, Biden aims to keep tax breaks for those earning less than $400,000. However, funding those extensions could be challenging due to the federal budget deficit.

According to Barry Glassman, founder and president of Glassman Wealth Services in McLean, Virginia, and a member of CNBC's Financial Advisor Council, if the tax cuts expire after 2025, muni bonds will become more attractive.

Credit risk for municipal bonds

The control of the White House and Congress can affect future credit risk, experts suggest. Besides taxation, lawmakers can also pass funding for state and local governments, thereby improving credit quality for muni bond issuers.

The American Rescue Plan of 2021, enacted during the Covid-19 pandemic, sent billions to state and local governments, thereby improving the credit quality of municipal bonds, according to Kozlik.

He remarked that we may never witness anything similar again.

As of March 31, 2024, the ratio of municipal credit upgrades to downgrades was 2.1 to 1, according to Moody's Analytics.

The federal exemption for muni bond interest

Some experts are concerned about the federal tax break for muni bond investors in addition to the looming 2025 tax cliff and federal budget deficit, according to Kozlik.

Despite the exemption remaining unchanged during TCJA negotiations, federal lawmakers made other changes that increased taxes on municipal bond issuers. One provision eliminated the tax-exempt status for "advance refunding bonds," allowing municipalities to refinance once before their bonds' redemption.

As 2025 nears, legislators will prioritize addressing the deficit and considering extensions to the TCJA. Although the tax exemption for municipal bonds is not immediately at risk, it may be reevaluated as lawmakers search for funding, according to Kozlik.