Guns, Butter, and Caviar

This really bugs me. Say you earn $10 million a year in tax-free municipal bond interest and so – quite legitimately – pay no income tax. And yet the radical left start screaming that you are sooooo rich and you pay nooooo tax. But the truth is that by accepting the lower rates that municipal bonds pay – thus subsidizing the borrowing costs of your state or city – you in effect are chipping in to the greater good.

As you can clearly see from this Bloomberg screen, 30-year U.S. Treasury bonds (which are subject to federal income tax) currently yield 4.66%, while the yield you accept when buying a 30-year Triple-A tax-free bond is 4.57% – nine basis points lower. Instead of getting $4.66 in interest on each $100, as you would from the Treasury, you are getting $4.57, which is nearly 2% less. So you’re not some centimillionaire paying no tax on his $10 million income; you are, in effect, paying nearly 2%. You are in the 2% tax bracket.

To be fair (which is never as much fun as being sarcastic, but something readers have a right to expect me to strive to be), it’s not quite this simple. Outrage is not necessarily the emotion I am going for here.

For starters, while you give up only $200,000 of income on every $10 million in annual income, the benefit to the issuing municipality is a good deal more. If their bonds weren’t tax-free, they’d have to pay a significantly better rate to attract buyers than the Treasury pays – even when they were selling triple-A bonds that are virtually as safe as Treasuries.

[Why? Well, for one thing, ‘virtually as safe’ is not the sort of phrase that appeals to nervous people. (Come fly our friendly skies! Our airline is virtually as safe as any other!) For another, it’s just so much easier to get in and out of Treasuries than it is to get in and out of less liquid municipal issues. (‘Our competitor’s flights leave hourly, no reservations required; we fly Tuesday and Thursday at 4:14pm and you have to pay a fee if you change your plans.’) So if they weren’t tax-free, triple-A municipal bonds might have to pay 100 basis points more than Treasuries, say, rather than 9 basis points less. For every $1 billion in borrowing, that would be $11 million or so a year more in interest costs.]

So I am not one who would do away with the tax exemption enjoyed by municipal bonds.

Nor am I one who would buy them today* – although certainly for a taxable account they are more appealing at today’s prices than Treasuries. (Why go for a taxable 4.66% when you can get 4.57% tax-free?)

*If I had $1 billion, I might well put $200 million of it into munis, just to throw off the income to run the house, chalet, plane and boat. But I am still roughly $1 billion shy of that mark.

I’d steer clear of long-term munis because:

In the long run, stocks are likely (though not guaranteed) to outperform long-term bonds, even the ones that are tax-free.

For the little guy buying $20,000 or $100,000 worth, it’s easy to pay more than you should when your broker sells them to you . . . and easier still to take a beating if you need to sell before maturity. (With municipal bond mutual funds, there’s a different problem: the annual fees dig deeper than I would like.)

And, mainly, the value of long-term bonds – whether taxable or tax-free – could be deeply eroded if, at some point in the next 30 years, we had a bad bout of inflation . . . as we did, say, after the guns-and-butter years of the Vietnam War.

For those not familiar with it, the phrase “guns and butter” refers to the idea of fighting a war without making the economic sacrifices to pay for it.

The Bush approach, “guns, butter, and caviar,” is unique in American history. You get your war without paying for it – and you provide a series of huge tax cuts for the rich.

And that gets me back to the real point of this column. It is not that rich folks should be criticized for buying municipal bonds – they should not. Or that the tax exemption on municipals should be repealed – it should not. It is simply that as we citizens attempt in good faith to make what is unquestionably a subjective judgment as to “what’s fair” . . . and as our Republican friends press relentlessly toward an ever more favorable split for the rich (reducing the inheritance tax on billion-dollar estates to zero, for example) . . . we should understand that triple-A 30-year tax-free bonds are not really tax-free – they subject their owners to the equivalent of nearly 2% in tax.

Too much? Too little? It’s just one more data point to consider as we decide how much further to shift fiscal burdens from the rich onto everybody else.