To the surprise of absolutely no one, many Americans feel they are paying too much in taxes. The passing last week of the income tax filing deadline is always a wake-up call for people to review their situation and explore legal ways to reduce their obligation to federal and state governments.
A Gallup poll released the day before the filing deadline finds 52 percent of people surveyed believe the federal income tax is too high and 42 percent say the rates are about right. Believe it or not, 3 percent view taxes as too low.
“Americans’ current views of the amount they pay in taxes represent a significant change from prior to 2003, when they were much more likely to say their taxes were too high," the survey said. "The lower percentage since 2003 who say their taxes are too high most likely reflects the effect of the 2001 and 2003 income tax cuts passed during George W. Bush’s administration.”
Before the tax cuts, as many as 69 percent of people surveyed said federal income taxes were too high.
For many taxpayers the current burden is still very severe. In California a taxpayer could find the combined state and federal income tax liability reaching as high as 52.9 percent after a couple of high-income surcharges.
As a result, many are turning to one of the few remain sources of tax-favored income: California tax-free municipal bonds. People in the higher tax brackets have quickly learned it’s not what you make on your investments, it’s what you keep.
As an example, a tax-free municipal bond, exempt from both state and federal income taxes, issued in California with an interest rate of 5 percent provides the same return as a taxable security yielding 9.23 percent for a taxpayer in the highest brackets.
However, while tax benefits are an important consideration when looking at an investment, there are several risks bondholders need to take into consideration as they select municipal bonds.
For several years the markets have been anticipating an increase in interest rates. Rising rates have a negative effect on the market value of all bonds and the impact is a function of the maturity of the issues. The longer the maturity, the greater the potential swing in values.
“In today’s low-rate and potentially volatile market environment, many investors are seeking an investment vehicle that provides a high level of current income while maintaining an emphasis on capital preservation," said James Miller, manager of the Fidelity Conservative Income Bond Fund.
"The short end of the fixed income market can offer investors an opportunity to generate a higher yield than a money market fund or a bank deposit account while experiencing lower price volatility than a longer-term bond.”
Where interest rates go from here, and the impact of municipal bond yields and values, will likely be determined by the actions of the Federal Reserve.
Recent comments by the Janet Yellen, the new Fed chairwoman, suggest short-term rates will likely stay near zero until 2016 and longer-term rates will likely hold at current levels, too.
Stable rates should provide some comfort to municipal bond investors.
However, taxpayers will get another reminder in a few days about how deeply taxes cut into their income.
The Tax Foundation reports Tax Freedom Day, the day when American’s collectively have earned enough income to pay off the total federal, state and local tax bills, arrives in the United States on April 21.
For Californians the pain lasts a bit longer. We won’t stop working for the government until April 30.