Newspaper article St Louis Post-Dispatch (MO)

Will Flat-Tax Bandwagon Flatten Muni Bonds?

Newspaper article St Louis Post-Dispatch (MO)

Will Flat-Tax Bandwagon Flatten Muni Bonds?

Article excerpt

Q. We've been investing in tax-free municipal bonds for years and now we're very concerned about a flat federal income tax.

Would you suggest selling off the tax-free bond funds in exchange for corporate bond funds?

M.Z.

Lemay

A. Don't worry. Be happy. Buy munis.

That's the answer from people who know a lot more about bonds than I do.

Yes, muni investors will get zinged if Congress passes a true flat tax a la Steven Forbes. But chances of that happening this year are zilch, and you'll have plenty of time to worry later.

In the meantime, all the flat-tax talk has made munis kind of cheap compared to taxable bonds.

"We think this is a buying opportunity," said Vicki Westall, a principal specializing in municipal bonds at Edward Jones.

Munis yield less interest than corporate and government bonds. People buy munis anyway because muni interest is tax exempt.

Forbes and other Republican flat-taxers would exempt all interest income from taxation. So, all bonds would become like munis.

As a result, muni buyers would demand higher yields to compete with corporate bonds. On the other hand, corporate bond buyers would accept lower yields because they'd no longer be taxed.

Yields on both types would meet somewhere in the middle.

Bond prices move the opposite direction from yields. So, muni prices would fall and corporates rise.

By how much?

The prices of long-term munis should drop by about 5 percent, says research director David Wyss of DRI/McGraw-Hill.

Shorter-term munis would drop less.

A 5 percent drop is about enough to eat up a year's interest on the bond. That's not enough to lie awake worrying about.

The waning fortunes of Steve Forbes are lessening chances that the next president will be a devout flat-taxer. But the bond market is made up of worrywarts, and they've worried the relative price of munis down to unusually low levels. …

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