WASHINGTON -- The amount of tax-exempt interest reported by individual taxpayers in 1989 surged 18.4% or $6 billion, to #38.8 billion, according to a report to be released Friday by the Internal Revenue Service.

The figures confirm what many in the municipal market have known for some time -- that individual investors are buying more tax-exempt bonds and taking p the slack left by the departure of commercial banks from the market, industry officials said yesterday.

"There's been a big shift in investors," said Andy Nybo, a research analyst with the Public Securities Association. "Since the 1986 Tax Reform Act, commercial banks have been steadily disinvesting from the municipal market while individual investors have been increasing their holdings of municipals."

The IRS report -- "Statistics of Income Bulletin, Spring 1991" -- will contain preliminary 1989 figures, the latest income statistics available. The figures were made availably by the IRS to The Bond Buyer along with final 1988 income data, which will not be released until next month.

According to the final 1988 data, individual taxpayers reported a total of $32.8 billion of tax-exempt interest for that year, about $1.8 billion more than the preliminary figures released by IRS last year.

IRS officials said there is a disparity between the two numbers because the final figures are based on actual returns, while the preliminary figures are based on the actual returns filed through September plus estimates of the returns that were expected to be filed through the end of that year.

The 18.4% increase in the tax-exempt interest reported from 1988 to 1989 tracks other available data showing a market shift, industry officials said.

For example, Federal Reserve Board data shows an 18.7% increase in the holdings of municipal bonds by households, money market funds, and mutual funds from 1988 to 1989, said Bruce Davie, a principal at Arthur Andersen.

And the PSA's data shows that holdings of municipal bonds by commercial banks dropped to $133.8 billion in 1989 from $151.6 billion in 1988, a decline of 11.7% Tax-exempt bond volume grew only 6.8% during the same period.

According to industry officials, banks have been both selling their existing municipal bond holdings and not replacing the tax-exempts in their portfolios that mature because of declining profitability and tax law restrictions.

Banks that have become less profitable do not need the tax advantage that municipals offer and are finding they can get better returns on taxable investments, they said. At the same time, the Tax Reform Act of 1986 eliminated the 80% deduction that banks could take for the purchase and carrying costs of all bonds except thos of small issuers who reasonably expect to sell no more than $10 million of tax-exempt governmental bonds per year.

The IRS data also shows that taxpayers with adjusted gross incomes of $50,000 or less reported $9.7 billion of tax-exempt interest, almost twice that of any other group of taxpayers. Taxpayers with adjusted gross incomes of $100,000 or less reported $18.1 billion of tax-exempt interest, close to the $20.1 billion reported by taxpayers with higher adjusted gross income levels.

"I think what you're seeing here is that the relative benefit of tax exemption has increased for those taxpayers in states and localities that have increased taxes," said Catherine Spain, director of the Government Finance Officers Association's federal liaison center. Those taxpayers, she said, "are able to exclude municipal bond interest from state and local taxes as well federal taxes for a triple benefit."

Several industry officials said that the 1989 data show a major market for municipal bonds, particularly among taxpayers with adjusted gross incomes in the $50,000 to $100,000 range. Only about 8.6% of the returns filed by these taxpayers reported tax-exempt interest from municipal bonds. At the same time, 45.2% of these returns reported dividends from stocks, and 93.4% reported taxable interest from certificates of deposit, Treasury securities, and other investments. A total of only $8.4 billion of tax-exempt interest was reported by taxpayers in this group, compared to $18.4 billion of dividends and $44.4 billion of taxable interest.

James A. Lebenthal, chairman of Lebenthal & Co., a retail investment banking house in New York City, said the industry could do more to market municipal bonds to this income group if it lowered the minimum purchase requirements and advertised more to explain what tax-exempt bonds are and how they are used.

"If you'll excuse me, I'm going to roll up my sleeves and sell the world more municipal bonds," he said. "I fell like a Peruvian fisherman who's just discovered the anchovies are back."

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.