Individual Tax Reform May Take `Two or More Years,' Says BofA

(Bloomberg) -- The sweeping changes the Trump administration hopes to make to individual taxes will likely be a long time coming, Bank of America Merrill Lynch's municipal research strategy team led by Philip Fischer writes in a report.

While administration officials have set a target date for the late summer to push through comprehensive individual tax reform, it could take two or more years to bear fruit as lobbyists press hard to protect their specific concerns. And the tax-exemption on interest income from state and local bonds is unlikely be going anywhere, as Treasury Secretary Steven Mnuchin stated in May that the administration's preference is to keep it.

Investors in municipal bonds "should be very wary," though, of efforts to remove itemized state and local tax deductions and adjust their portfolios accordingly. The report recommends acting "defensively" and buying in-state paper. If the deductions are nixed, it would effectively raise the cost of government and tax rates for high-income earners. High-tax burden states would be hit hardest -- for example New York and California, where current deductions make up 9.1 percent and 7.9 percent of adjusted gross income, respectively.

A removal of such deductions would save the federal government a hefty sum, boosting coffers an anticipated $1.4 to $1.8 trillion over ten years, said Fischer in a phone interview. This would push the cost of tax reform down onto states and localities that will feel the squeeze of a 'proportionately poorer' citizenry while being forced to increase taxes if they wish to maintain current services, said Fischer.

Ratcheting up taxes is a tricky business though, and something the distracted Trump administration may not be able to push through, says Jeffrey Lipton, head of municipal research at Oppenheimer & Co.

"As a negotiating tool it may take up a greater part of the narrative, but at the end of the day we do not envision a tax reform package that includes the elimination for the state and local tax deduction," said Lipton in a phone interview. "We are cautiously optimistic that an ultimate tax reform package would not contain any overly detrimental elements to the municipal market."

Lipton says there is a greater push to pursue corporate tax reform in the near term because there is greater consensus in the legislature.

"Where the uncertainty lies is on the corporate tax side. If the corporate tax goes from 35 percent to 20 or 25 percent, that could have an impact on demand and valuations and potentially see a repricing along the muni curve," said Lipton.

To contact the reporter on this story: Kristy Westgard in New York at kwestgard1@bloomberg.net.

To contact the editors responsible for this story: Christopher Maloney at cmaloney16@bloomberg.net, William Selway