Market Frets About Threats to Tax-Exemption

Tax proposals from Republican presidential candidate Mitt Romney would help drive municipal yields to the highest level since March by ending the debt’s tax advantage at lower income levels, Morgan Stanley estimates.

Romney, who trailed President Barack Obama in some national polls this month, recommends ending federal taxes on interest, dividends and capital gains for those earning less than $200,000 annually.

The shift would make issuers in the $3.7 trillion muni market compete on an equal footing with company and federal debt at those income levels, pushing up local yields.

If Romney, 65, also curbs munis’ exemption for wealthier investors, 10-year local yields would rise 0.49 percentage point to levels not seen in six months, Michael Zezas at Morgan Stanley wrote in a Sept. 4 report.

The former Massachusetts governor hasn’t proposed that step, though he has called for lower tax rates and ending unspecified breaks.

“There is a blend of factors in Romney’s plan that potentially impact munis’ tax value in a negative way,’’ said Zezas, Morgan Stanley’s head muni strategist in New York.

State and local debt tends to yield less than other fixed-income investments because of its tax-free income. Excluding interest on munis from federal taxation may cost the U.S. government $306 billion from 2013 to 2017, according to Morgan Stanley’s report.

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