Muni Outlook for 2025: Tax Policy Takes Center Stage; Muni Tax Exemption Once Again Up for Debate; Market Wrestles With Financial Data Transparency Act Compliance, Climate-Conscious Infrastructure Needs

The municipal market is bracing for a 2025 inundated with regulatory uncertainty regarding compliance with the Financial Data Transparency Act and the fate of the 2017 Tax Cuts and Jobs Act. While market participants wait for the policy shoe to drop, muni issuance is expected to be robust for at least the first half of the year. High-yield muni supply, however, will likely remain subdued given that tight credit spreads are here to stay, sources tell Octus, formerly Reorg.

“Whichever way you look at it, at least in the near term, there’s going to be deficit spending and the implication may be persistent or higher inflation,” said Mohammed Murad, head of municipal credit research at PT Asset Management. Inflationary pressures will continue burdening many sectors “but mainly healthcare because it’s lagging behind other muni sectors in terms of recovery,” Murad added.

While the market has seen some improvement in certain healthcare borrowers who were able to cut expenses through downsizing their workforce, renegotiating contracts with vendors and restructuring their debt, “prices of virtually everything have gone up and haven’t come down,” Murad explained.

Capital costs for large projects as well as operating and maintenance costs in healthcare and other sectors are expected to remain high in the near future, especially when potential tariff spikes under the Trump administration are put in place, driving up prices of imported goods.

What Does FDTA Compliance Look Like for Muni Borrowers?

The launch of Electronic Municipal Market Access, or EMMA, by the Municipal Securities and Rulemaking Board, or MSRB, in 2008 provided a central repository for municipal bond disclosure requirements, but ease of disclosure, navigation and extrapolation severely lags other fixed income markets. For example, financial disclosures uploaded as a PDF file many times turn out to be scanned images that are neither machine readable nor searchable.

That reality might belong to a bygone era with the Financial Data Transparency Act, or FDTA. The FDTA, which was signed into law in December 2022, mandates across all issuers common identifiers, structured data format and machine-readable annual comprehensive financial reports.

The final rules that dictate how the FDTA standards are applied across the board will be announced by the statutory deadline of Monday, Dec. 23, and issuers have two years from this date to comply with the ruling. The public comment period regarding the proposed rules of these joint standards concluded on Oct. 21, including submission from the Government Finance Officers Association, or GFOA, National Federation of Municipal Analysts, and Public Finance Network.

“One of the advantages of structured data is that each piece of information is defined separately,” said Bill Glasgall, senior director of public finance at the Volcker Alliance. It would be beneficial to the investor community as prospective investors can analyze issuer data more efficiently instead of buying data from service providers, he said.

A lot of smaller issuers, however, do not have the expertise or the resources to make such sweeping changes to an existing disclosure system, Glasgall cautioned.

“What it seems like Congress wants is the financial reports of any given city or university to look like those of Coca Cola and Hewlett Packard in the corporate world,” said Emily Brock, director of the federal liaison center for the GFOA.

The municipal market has an estimated value of $4.1 trillion in bonds outstanding across roughly 80,000 issuers with more than 1.5 million individual securities, according to data from SIFMA. This stands in stark contrast with the corporate market, which holds about 30,000 different securities, many of which are much bigger and issue debt more often than municipal issuers.

New disclosure requirements under the FDTA would create more obstacles for the universe of municipal borrowers, which includes many small, rural communities with limited resources that have already complied with a robust system of disclosures. “Any dollar required to comply with this law is an unfunded mandate, pushing issuers out of the market,” Brock said.

“The U.S. Securities and Exchange Commission needs to understand that there are practices currently in place that satisfy the objective of the legislative intent [and that] it cannot directly regulate state and local governments,” she said, citing the Tower Amendment, a 1975 addition to the Securities Change Act of 1934 that bars the SEC and the MSRB from directly regulating municipal issuers.

How Does Muni Math Fare Against the Tax Cuts and Jobs Act?

When the Tax Cuts and Jobs Act, or TCJA, passed during Trump’s first term in 2017, the bill projected a cost of $1.5 trillion over a 10-year period. In 2024, that bill is now estimated at $4.6 trillion, according to a May report by the Congressional Budget Office. Furthermore, the tax exemption for municipal bonds could once again be on the chopping block to reduce tax expenditures.

The passage of the TCJA in 2017 marked the elimination of private activity bonds and one-time advanced refundings in the municipal market. “Knowing what we went through in 2017, [Congress] will be looking under every rock for all the money they can get to pay for any extensions of any provisions under the TCJA,” said Brock of the GFOA. As a result, a bigger discussion about muni tax exemption and how much it costs the government has reemerged.

The Joint Committee on Taxation estimates that tax exemption for municipal bonds will cost $135 billion over five years, Brock cited. “If [Congress] comes in and asks us to defend this expenditure, I would say ‘your $135 billion is a fraction of the benefits of the communities that receive and utilize the tax-exemption,’” she said.

Opponents of the muni tax exemption argue that the tax exemption is a subsidy for the wealthiest to get even wealthier, but Brock underscores the importance of arguing “both sides of the coin.” Muni investors have made massive investments in 80% of U.S. infrastructure, and if every tax-exempt bond that is issued were suddenly switched to taxable, “the additional cost to muni borrowers would be at least 200 bps,” she said.

Other market participants, however, are more optimistic about how budget reconciliations might unfold. “We believe there’s a low probability that the exemption gets repealed because it would do more harm than good,” according to Cooper Howard, director of fixed income strategy at Schwab Center for Financial Research. Taking away the muni tax exemption would do little to help raise revenue to help pay for the TCJA, he explained, because out of all income tax items as reported annually by the U.S. Department of the Treasury, it is only the 18th largest cost on the list.

Market Outlook for 2025

2024 had record issuance, but high-yield supply was at a record low – and that is going to be the same case going into 2025, said James Pruskowski, chief investment officer at 16Rock Asset Management. “Senior living and charter schools deals that define the high-yield market are no longer happening to the degree that they did in terms of new build,” he said.

By the end of October, there had been 18 consecutive weeks of fund inflows out of the 35 inflow weeks with about $441 billion in total supply year to date, according to PT Asset’s Murad.

If you zero in on the high-yield segment of the market and particularly on deals that were oversubscribed, however, investors have been “getting a smaller spread, which means you may be overpaying for risk,” Murad said. “There’s just too much money chasing very few deals,” he added.

Another costly aspect of the muni market has to do with insurance related to extreme weather events, which have been happening more frequently and causing more damage to infrastructure all around the country. In addition to driving up insurance expenses, natural disasters have the potential to help expand the market more broadly, sources tell Octus.

The muni market has been valued at about $4 trillion for at least 10 years, so in real terms, it has actually shrunk, but “there’s certainly a need for more issuance to harden and improve infrastructure,” Glasgall argued.

While the legislative backdrop going into the new year remains uncertain for climate protection, the market may expect “some sort of surge in ESG bonds or catastrophic bonds to help repair some of the damage and to get ahead of future natural disasters in the south[ern], southwestern and northeastern states,” Glasgall said.

The symbiotic relationship between extreme weather and the municipal market is not difficult to imagine. For instance, drought affects water supply and water quality, which in turn could have a direct impact on utility authorities, Murad said.

“If these events are very frequent, there could be a migration trend, tax base erosion, less sales tax collection,” he added. “That’s just a case for why you need climate resilience.” Wildfires in California, hurricanes in Florida and the increase in cold snaps like the not-so-distant memory of the historic Winter Storm Uri in Texas in 2021 have garnered increasing attention from muni analysts and investors as they go through credit selections.

“We’re getting more billion-dollar storms than we did 20 or 30 years ago, which means that [the Federal Emergency Management Agency, or] FEMA, is spending down a lot of these federal dollars [more quickly] than they have in their disaster relief fund,” Murad said.

This, in turn, influences how long it takes for a credit to receive some of its reimbursements from FEMA. To mitigate reimbursement timing, liquidity and access to capital markets are some factors that could be considered when looking at credit quality, he said.