President Biden’s recently proposed American Jobs Plan outlines a robust strategy to rebuild the nation’s infrastructure; providing funding for projects like roads, bridges, public transit, and airports, while also including significant funding for clean energy, electric vehicles and affordable housing. Importantly, any infrastructure initiative will need to be coordinated across federal, state and local levels, thereby having a sizable impact on the municipal bond market.
While negotiations are still ongoing, proposals within the plan could impact the supply of municipal bonds in a couple of ways:
- The administration is likely to reintroduce a program similar to the Build America Bonds (BABs) program authorized in 2009/2010, which featured a federal subsidy to municipal issuers. Recent proposals suggest subsidies of 42% in year-one, tapering down to 30% in following years, on taxable issuance under the program, which would meaningfully offset issuer borrowing costs. This could bring a wave of new taxable municipal debt to the market.
- Reinstating tax-exempt advance refunding’s for municipal bonds may be included in the new legislation. This would be welcomed by all issuers and depending on the level of rates upon passing, could also lead to an increase in tax-exempt municipal supply.
Tax revenue proposals are expected to impact the demand for municipal debt as well. The spending and tax increases built in the American Jobs Plan are part of a larger, Build Back Better initiative, which is expected to be funded through a variety of personal tax increases. This is important as higher personal income tax rates is likely to support strong demand for muni debt from high earners and individuals in high tax states, particularly if the current cap on SALT deductions are maintained.
In summary, an infrastructure plan this size could mean a large wave of taxable municipal supply through a BAB-like program. For perspective, the BAB program brought roughly $180bn in new taxable municipal debt to the market, most of which was high-quality, long-dated paper. Moreover, reinstating advance refunding for tax-exempt debt, could usher in a wave of tax-exempt issuance as well, if rates stay low enough where it’s attractive for issuers to advance refund.
Furthermore, with state and local fundamentals well supported by direct and indirect federal aid and a rapidly improving economy, rich valuation across the municipal bond market are likely to persist. Moreover, the potential for higher tax rates increase the relative value of municipal bonds, supporting demand for municipal debt. Lastly, depending on when reconciliation might occur, this wave of issuance may not materialize until the fourth quarter and possibly next year, likely pushing the risks of a policy-driven supply shock out a few quarters.
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