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Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income by Triet Nguyen

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Prospects for Tax Reform

At this writing, tax reform appears to be on its way to becoming one of the leading issues of the 2012 presidential campaign. The flat tax proposal, which caused short-term havoc on the tax-exempt market 15 years ago, is being revived once again under various guises by some Republican candidates. In contrast to the last iteration, the probability of some kind of tax reform being enacted seems much higher this time around, reflecting heightened concern about the federal budget and deficit outlook. Ironically, the success of the Build America Bond program, however short-lived, did demonstrate that there can be a viable muni market with a direct subsidy mechanism instead of tax exemption. While an outright assault on tax exemption cannot be ruled out, it is reasonable to expect at a minimum some degree of curtailment of the tax exemption benefits enjoyed by high-income earners. That would imply a rise in tax-exempt yields to reach parity with other taxable instruments. While we do not expect any real action to be taken until after the election, the increasing chatter about tax changes is certain to introduce more volatility into the muni market during this election year.

As far as the high yield muni market is concerned, full taxability is always a distinct risk for those sectors that may be viewed as abuses of the tax code; that is, the small private activity and industrial development issues. They have in fact accounted for a disproportionate share of historical ...

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