· Tax Exemption Preserved: The OBBBA maintains the federal tax exemption for municipal bond interest, reinforcing a key advantage for issuers and sustaining investor demand—especially important in a market with some of the highest taxable-equivalent yields since 2008.
· Medicaid and Disaster Funding Shift: The legislation transfers $219 billion in Medicaid and SNAP costs to states and introduces stricter FEMA cost-sharing rules, increasing fiscal pressure on high-utilization states, small hospitals, and disaster-prone localities.
· Issuance Expected to Rise: Reduced federal aid, tighter Medicaid funding, and expanded eligibility for Private Activity Bonds are likely to drive increased municipal bond issuance, both out of necessity and opportunity, as governments seek capital to maintain services and fund infrastructure.
SUMMARY
While the municipal bond market avoided one of the biggest threats, an elimination of tax-free financing, there are, and will be, many ripple effects stemming from the One Big Beautiful Bill Act (OBBBA), and we will be closely monitoring and managing our clients’ portfolios to continuously adapt.
Tax Exemption
The One Big Beautiful Bill preserved the federal tax exemption for municipal bond interest, maintaining a key advantage for issuers and investors. The exemption remains a foundational pillar of the municipal market, helping state and local governments borrow at lower interest rates while offering investors tax-advantaged income. The decision to leave this benefit untouched provides continued support for municipal credit by preserving issuers’ access to cost-effective financing for infrastructure, education, healthcare, and other essential public services. It also helps sustain investor demand, particularly among high-net-worth individuals and institutions seeking tax-advantaged income. We feel the questions of exemption being put to rest will provide the demand ballast to a market now with some of the highest relative taxable equivalent yields we have seen since 2008.
Medicaid Cuts
Perhaps the most consequential change for the municipal market will be the cuts to Medicaid and their implications for the shifting costs to states and local governments. The OBBBA significantly shifts Medicaid policy by transferring approximately $219 billion in Medicaid and SNAP costs to states over the next decade. Key changes include tighter eligibility requirements and caps on provider taxes, with expansion states facing a phased reduction in provider tax rates from 6% to 3.5%. These changes could reduce federal matching funds and strain state budgets, particularly in high-utilization states such as California, New York, and Texas. Hospitals may face lower reimbursements and increased charity care burdens, while states may be compelled to explore new revenue sources or restrict benefits to close funding gaps.
Matthew Riggle
Co-Director of Research
· We believe there is a strong chance that municipal bond issuance will increase significantly as states and local governments face growing fiscal pressures.
· This may seem like a lot for the municipal market to handle, and it certainly is, but we still like to remind our clients of the strong overall credit quality in our market.
· We continue to selectively buy higher education credits in this market, and we are very careful to purchase these names at appropriately adjusted spread levels.