Markedly Few Well-to-Do American Taxpayers Declared Municipal Interest Income in 1989

Surprisingly few individuals are taking advantage of tax-exempt securities, even though they would benefit from buying municipals, according to an analysis of tax returns by the Public Securities Association.

Only 14% of taxpayers with adjusted gross incomes from $75,000 to $100,000 per year reported tax-exempt income, and only 7% of those making $50,000 to $75,000 said they had municipal interest income. The conclusions were drawn from Internal Revenue Service data on 1989 tax returns - the most recent available.

PSA officials attributed the poor showing to a basic ignorance of municipal bonds. "Investors who should be considering municipal bonds as part of their portfolio are unaware of the benefits," said Heather L. Ruth, president of the trade association.

On the other hand, individuals reported an 18% increase in tax-exempt income, to $38.8 billion from $32.8 billion. And the number of taxpayers filing with tax-exempt income increased 8.5% in 1989, to 3.8 million from 3.5 million.

The tax filing data, interestingly, almost exactly match the proportional increases reported by the Federal Reserve Board's Flow of Funds Accounts, despite the "residual" nature of the Fed's data. Households owned $378.5 billion in 1989, 18.5% more than the $319.2 billion held in 1988, according to the Federal Reserve.

Municipal analysts suggested that the taxpayers making $50,000 to $100,000 may look better on paper than in reality, that they may not have investments at all due to high expenses. But the PSA study notes 57% of those making $75,000 to $100,000 also received dividend income from equities, while 42% of the $50,000 to $75,000 sector received such dividends.

Progress, on a percentage basis, is most evident in the $75,000 to $100,000 income sector. The number of filers declaring tax-exempt income jumped 22%, to 436,000 from 358,000 in 1988. And the interest income reported soared 41%, to $3.8 billion from $2.7 billion.

Demographic studies of the $50,000 to $75,000 group, however, suggest tax-exempt penetration of this sector may be difficult. The U.S. Bureau of the Census reported that more than 45% of these taxpayers in 1988 were 30 to 45 years old, when taxpayers' economic emphases are on acquiring property and investments tend to be riskier. The stodgy 7% revenue bond is far less sexy than 100 shares in a biotech company.

In addition, the "upscale" households in this same income sector are likely to have very little discretionary income because of "multiple demands" on funds. Such pressures include paying for old college loans, making proportionally stiff mortgage payments, caring for parents and children, and trying to save for retirement, according to American Demographics magazine.

"One of the problems is that the baby boomers have been looking at big-ticket expenditures," said Andy Nybo, research analyst at PSA. "Only now are they looking at tax-exempts."

Neal Atterman, vice president of research at Kidder, Peabody & Co., suggested that this group's "unawareness" of municipal bonds could extend to how tax-exempt income can be acquired. "They may be thinking they have to buy a round block and not recognize what they could do through [unit investment trusts] or funds," Mr. Atterman said.

Most individuals making more than $50,000 would still do well to buy tax-exempt securities, either directly or through "packaged" investments, such as unit trusts or mutual funds, according to taxable-equivalent return studies. Even without incorporating the state and local income tax exemption, someone making more than $34,000 would have to get a 9.72% taxable return to achieve a 7% municipal bond return, the PSA says.

And for taxpayers in heavily burdened locations like New York City, Massachusetts, and California, the after-tax returns are far higher.

The most fertile ground for future tax-exempt bond buying, on a population basis, appears to be the pressured $50,000 to $75,000 sector. In 1989, it was the single largest group of Americans, comprising more than 13% of all households, according to American Demographics.

Yet only 7% of these taxpayers own municipal securities.

Expanding the bond-buying community to the below-$50,000 income bracket also will prove difficult, although this vast sector already accounts for about 27% of the $38.8 billion in tax-exempt income reported. The problem is that lower incomes correspond with younger households, until the below-$20,000 sector when retirees begin to swell the ranks.

A study earlier this year by the National Bureau of Economic Research based on 1987 tax returns, concluded that tax-exempt securities were concentrated in the hands of the wealthy. The PSA analysis of 1989 returns confirms that fact but sheds more light on the holdings.

Slightly more than half of the tax-exempt interest reported on tax returns in 1989 was held by taxpayers making more than $100,000, according to PSA's study. Demographically, however, the concentration is intense. The over-$100,000 crowd - half of which are aged 40 to 55 - holding municipal bonds represented a mere seven-tenths of 1% of all taxpayers.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.