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Will Small Investors Get Lured Into Munis?

Photo by: John Carney

A Senate proposal might make municipal bonds more attractive to investors in lower-income brackets, and less attractive to those in higher income brackets.

It’s hard to imagine a worse time to lure new, inexperienced and probably uninformed lower-income earners into this market.

The bill was introduced last week by Senators Ron Wyden, the Democrat from Oregon, and Dan Coats, the Republican from Indiana.

It would eliminate the automatic tax-exemption for interest earned on muni bonds. Instead, it would give bond holders a tax credit for 25 percent of the interest earned on the bonds.

This would make "munis less attractive to investors in higher tax brackets, but more attractive to investors in lower tax brackets," according to a note from Merrill Lynch municipal research strategist John Hallacy that was quoted by MarketWatch.

Demand for muni bonds is at a record low. It seems that lawmakers hope to juice the market by making the bonds appealing to a broader class of buyers.

Of course, if the muni market blows up—as it very well might—these new, lower-income investors will get burned. What’s more, introducing a new class of investors into the market could have potentially destabilizing effects. Introducing new and unpredictable factors in the market is probably a terrible idea.

Merrill’s Hallacy doesn’t think too many lower-income investors will actually enter the market. In his view, the result will just be lowered demand for muni debt.

So this plan will either lure new, lower-income investors into an already shaky market—or it will just result in a flight of high-income investors, driving up rates for states and cities trying to borrow.

Grand plan, fellas.

(Hat Tip: Cate Long's excellent Muniland blog.)

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