WASHINGTON – The findings of a recent study that fewer individual investors are holding municipal securities and that more munis are being held by the wealthiest may make it harder for market participants to convince some lawmakers that tax-exempts are not just a tool for the rich.

The findings are from the study, "Changing Patterns in Household Ownership of Municipal Debt" by Daniel Bergstresser, an associate professor of finance in the Brandeis International Business School, and Randolph Cohen, a senior lecturer at the MIT Sloan School of Management.

The study examined household ownership of munis between 1989 and 2013 and used information from Surveys of Consumer Finances (SCF), which survey U.S. households every three years. The Federal Reserve Board conducts the surveys in cooperation with the Internal Revenue Service.

The paper's authors found that the share of households holding municipal debt, either directly or indirectly through mutual funds, fell to 2.4% in 2013 from 4.6% in 1989. They also found that the share of total debt held by the wealthiest 0.5% of households rose to 42% from 24% over the same period.

Bergstresser and Cohen attribute the decreases in household share of muni holdings to the fact that more households are investing in tax-deferred retirement investment accounts like 401(k) plans. Individuals can maximize such tax-deferred accounts by holding highly taxed assets, according to other studies cited by the two researchers.

"For a household to hold tax-exempt municipal bonds inside of a tax-deferred account would contradict the most basic advice of the asset location literature," they wrote. They added that the share of households holding stocks, a more highly taxed asset, grew to 42.7% in 2013 from 27.3% in 1989.

In the section of the study that discusses the gap in holdings between the wealthiest households and all others, the authors use the mean and median levels of ownership to show the large upward pull that wealthy holders have on the data, which, they write, makes those calculations "highly skewed." The median ownership level for 2013 was $70,000, the study found, while the mean or average was $432,000.

The separation is also seen when holdings of households in the 95th percentile, which increased to $1.8 million in 2013 from $751,613 in 1989, are compared to holdings in the 50th percentile, which have only grown to $70,000 in 2013 from $47,000 in 1989.

[Image: Bloomberg]
[Image: Bloomberg]

Bergstresser and Cohen conclude from their data that the declining ownership of municipal debt could be a "cause for concern from a political economy perspective" because fewer households and thus voters can be counted on to "form a reliable voice in favor of repaying debt."

They also wrote that another area of potential concern is the tax exemption for munis, which some lawmakers and administration officials have proposed be capped or eliminated to broaden the tax base and make the tax system fairer to middle income earners. President Obama has proposed capping the value of the tax exemption for municipal bond interest at 28% in every budget proposal he has released in recent years. The comprehensive tax reform plan floated by former House Ways and Means Committee chair Dave Camp, R- Mich., would have imposed a 10% surtax on muni interest for high income earners.

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"A declining share of households who hold municipal bonds and perceive themselves as benefiting from the tax exemption may place this exemption on a shakier political foundation," Bergstresser and Cohen wrote.

Several muni market groups disagree with the paper's conclusion, saying it only accounts for one "side of the coin" in the debate over tax exemption.

Emily Brock, director of the Government Finance Officers Association's federal liaison center, said the study shows "an interesting trend" that GFOA will pay attention to but misses the idea that the tax exemption serves as a partnership that benefits both investors and issuers. The current exemption structure allows issuers to go to the market more cheaply than they would if the tax exemption did not exist, allowing for cost-effective infrastructure improvements for municipalities, Brock said.

GFOA is going to continue spreading this message to congressional representatives, she added.

Jessica Giroux, general counsel and managing director for Bond Dealers of America, said that it is important to look at the ratepayers and taxpayers who also benefit from issuers going to market to build their projects at a lower cost.

"BDA has always emphasized the economic benefits currently accruing to municipalities and citizens associated with the lower costs of financing local projects with tax exempt bonds and we will continue to educate Capitol Hill about the value in maintaining the tax exemption," she said.

Both Giroux and Brock also disagreed with the study's concerns about repayment of debt, saying issuers have more incentive to repay their debt on top of political pressure. They both gave the example that a municipality that defaults would have a much harder time returning to the market than one that keeps up with its payments.