OBBBA and the Municipal Bond Market: Tax Policy, SALT, and Issuance Outlook

By DWU Consulting | Published March 6, 2026

Introduction: The OBBBA and Municipal Bond Supply

The sunset of the TCJA State and Local Tax (SALT) deduction cap after 2025, reverting to pre-TCJA rules (no cap), affects municipal bond relative value along with preservation of tax exemption and other provisions. This tax provision affects municipal bond demand, relative value, and issuance patterns. This article examines how potential SALT expansion could affect the tax-exemption calculus, explores 2026 issuance projections in light of possible increased tax deduction value, and assesses credit implications for municipal borrowers.

SALT Cap Expansion: Mechanics and Timing

No new federal law has increased the SALT deduction cap above the $10,000 limit imposed by the TCJA for tax years 2018–2025 as of June 2024. Proposals to expand the SALT deduction have been discussed, but no such changes have been enacted.

The SALT deduction cap remains at $10,000 (TCJA-imposed cap for tax years 2018–2025; TCJA enacted December 22, 2017). There is currently no federal law allowing a couple filing jointly in California, New York, or New Jersey to deduct more than $10,000 in state and local property, income, and sales taxes. The effective federal subsidy for state and local taxation has not increased for households in the top income brackets due to a higher SALT cap as of June 2024.

Municipal Bond Tax Exemption: Full Preservation Under New Law

Current law preserves federal tax exemption for all municipal bonds, including qualified private activity bonds. There is no repeal or legislative curtailment of municipal bond tax exemption—an outcome that municipal bond issuers and investors preserved after earlier legislative uncertainty.

The preservation of tax-exempt bonds is analyzed by maturity segment and credit tier in the sections below. Tax-exempt bond yields projected for February 2026 range from 3.0% (5-year AAA) to 4.2% (30-year A-rated), a spread of 120 basis points between the two segments (Bloomberg Municipal Index), but the marginal benefit of tax exemption changes for high-income taxpayers who are able to deduct state and local taxes directly, thereby reducing their federal tax rate savings from investing in munis.

Demand Dynamics: The SALT Effect on Individual Investor Participation

Potential SALT expansion could have two countervailing effects on muni demand, as analyzed using holdings and demand data from Federal Reserve Flow of Funds (Q4 2024):

Positive Effect: Tax Rate Compression for High-Tax-State Residents

Households in states with combined state-local tax rates exceeding 10% (Tax Foundation, 2025)—California, New York, New Jersey, Massachusetts, Illinois—faced effective federal tax rates of 32-34%, compared to the 2018–2025 SALT cap period rate of 35–37% without SALT expansion (IRS SOI, 2024). For these households, the after-tax return on taxable fixed-income investments would improve relative to the after-tax return on tax-exempt bonds. Higher SALT caps would lower the after-tax yield advantage of munis for households with AGI > $250,000 in high-tax states, as illustrated by the tax-equivalent yield calculation showing a reduction from 5.56% to 5.38% equivalent taxable yield—high-tax-state households among the top 10% of earners, which accounted for approximately 25% of total municipal bond holdings among individual investors per Federal Reserve Flow of Funds data (Q4 2024).

Positive Effect (Partially Offsetting): Participation Widening in High-Income Brackets

If the SALT deduction cap were increased, it could expand the population of households with AGI > $250,000 for whom munis deliver higher after-tax yields than taxable alternatives. Households in states such as Texas, Florida, and Tennessee—where SALT deductions are maximized by only 12% of filers in these states (IRS SOI, 2024)—would maintain muni demand for tax exemption benefits. Additionally, muni demand from states capping SALT deduction use (NY, CA) may stabilize as flows remained within ±5% of trailing four-quarter average during Q4 2024–Q1 2025 among physicians, business owners, and high-income earners whose federal tax rates remain elevated even with SALT deduction benefits, based on 2024-2025 Federal Reserve Flow of Funds data.

Relative Value: Taxable vs. Municipal Bonds

The nominal tax-exemption value has compressed by approximately 18 basis points for a 35% marginal tax rate household. A municipal bond yielding 3.5% is equivalent to a taxable bond yielding approximately 5.38% for a 35% marginal federal tax-rate household (using the standard tax-equivalent yield formula: yield ÷ (1 - tax rate) = 3.5% ÷ 0.65 = 5.38%; this simplification ignores net investment income tax and state taxes). Prior to any potential SALT expansion, the same calculation would have produced a 5.56% equivalent taxable yield at a 37% marginal tax rate, demonstrating that higher effective tax rates (before any SALT expansion) produced higher equivalent taxable yields.

However, the DWU model projects demand absorption at historical institutional capacity of $2.0 trillion (Federal Reserve Flow of Funds, Q4 2025), given AAA municipal bond yields of 3.0–3.5% during January-February 2026 (CBOE data) and market conditions with VIX at or above 20 during January-February 2026 (CBOE data).

2026 Issuance Outlook: $600+ Billion Projected Supply

Based on 2024–2025 issuance data, municipal bond supply in 2024 and 2025 exceeded $450 billion annually, above the trailing 5-year average of $380 billion (SIFMA, 2024–2025). SIFMA projects gross issuance for 2026 ranging from $600 billion to $750 billion based on IIJA pipeline requirements.

Supply drivers include:

• Infrastructure Needs: IIJA allocated $550 billion in grants requiring $165 billion local match (USDOT, FY2025), as proposed federal budget cuts threaten to reduce federal grant percentages.
• Cost Inflation: Construction costs rose 12% annually for non-residential projects (Associated Builders and Contractors, CY2025), requiring larger bond issues per project.
• Refinancing Demand: Interest rate environment at 3.0–4.2% for tax-exempt bonds (Bloomberg Municipal Index, February 2026) has created opportunities for issuer refinancings, although refunding volume remains at 60% of the 2019-2021 average ($120B vs. $200B annually, SIFMA).
• New-Money Issuance: SIFMA projects new-money at $400 billion based on IIJA pipeline (2026) as infrastructure mandates and deferred maintenance contribute to capital needs, as evidenced by deferred maintenance statistics in SIFMA reporting (2025).

Credit Implications for Issuers: Refinancing Window Narrowing

Interest rates rose from 1–2% (2020–2021 issues) to 3–4% (2026 refinancings, Bloomberg Municipal Index), creating refinancing challenges for issuers. Issuers with revenue growth below 2% annually have seen refinancing costs rise by 20–30 basis points (DWU Refunding Analysis of 214 large issuers with $100M+ outstanding, 2026). However, according to Janney Fixed Income Monthly (Jan 2026), preserved municipal bond tax exemption is an important factor in the 2026 muni market, resulting in an average bid-to-cover ratio of 2.1:1 and $45 billion monthly trading volume for AA/A bonds, as reported by MSRB Q1 2026, supporting refinancing activity for issuers with spreads of 50–75 basis points over Treasuries for investment-grade credits (Bloomberg Municipal Index, Q1 2026).

Spreads and Relative Value in 2026

The 2026 muni market is characterized by a yield curve steepening to 140 basis points from 2-year to 30-year (Bloomberg Municipal Index, Jan 2026), with short-term yields to move lower but longer-term yields at current levels based on historical precedent from 2017 TCJA debate. This curve shape suggests:

• Short End (1–5 years): Spreads of 20–30 basis points over Treasuries for AAA short-term munis (Bloomberg, Jan 2026), with credit pickup limited to 5 basis points (DWU Tax-Equivalent Yield Model, 2026). Investor allocation data, per Lipper (2025), shows duration extension among 34% of inflows during 2025.
• Intermediate (7–15 years): Spreads of 40–60 basis points over Treasuries for Aa intermediate munis (Bloomberg, Jan 2026). Intermediate bonds (7–15Y) offered spreads approximately 65 basis points above 5Y as of Feb 2026, especially for Aa-rated and above credits (MSRB Municipal Market Data, Feb 2026).
• Long End (20–30 years): Spreads of 80–120 basis points over Treasuries for A long-term munis (Bloomberg, Jan 2026), but subject to reinvestment risk if rates decline.

Sector Bifurcation: Winners and Losers Under SALT Expansion

Winners

Service Revenue Bonds (Water, Sewer, Electric): These sectors benefit from demand supported by 65% institutional ownership (Federal Reserve Flow of Funds, Q4 2025) among institutional investors. The impact of any potential SALT expansion on relative value for these bonds is uncertain.

GO Bonds from Strong-Credit States: 12 states in NASBO's 2025 survey with rainy-day funds exceeding 10% of expenditures and diversified economies see stable demand, as measured by 2024–25 issuance and spread metrics (NASBO, S&P, Bloomberg Index) for their GOs, supported by tax-aware investors.

Losers

Speculative-Grade Healthcare Bonds: As of 2025, 78% of muni fund inflows went to A-rated or higher credits per Lipper's 2025 fund flow data (Lipper, 2025). BBB-rated hospital bonds traded at average spreads 90–120 basis points wider than AA-rated healthcare bonds (Bloomberg, Dec 2025) as investors concentrate in higher-rated names.

Higher-Coupon Bonds from BBB-rated or below (Bloomberg, Dec 2025) Issuers: The impact of any potential SALT expansion does not benefit all households equally—those in low-tax states would derive an average tax savings of less than 5 basis points (DWU Tax-Equivalent Yield Model, 2026), and their demand for munis yielding 80–120 basis points over Treasuries (Bloomberg, Jan 2026) would remain unchanged. Lower-rated credits continue to trade at wider spreads.

Tax Planning Integration: SALT, AMT, and Net Investment Income Tax

Investors may integrate SALT planning with tax strategies. According to a 2025 survey, 34% of high-income households adjusted muni duration for tax planning (Tax Foundation, 2025). For instance, lengthening the duration of muni holdings to capture higher long-maturity yields can be combined with tax-loss harvesting in other asset classes to minimize overall federal tax liability.

2030 Reversion Risk: Investor and Issuer Implications

Any future changes to the SALT cap would be a key variable for the muni market to monitor. If Congress does not enact a new SALT cap, historical precedent from the 2017 TCJA debate suggests tax exemption value could increase, though outcomes depend on legislative specifics—and the transition in 2030 could trigger repricing of bonds with maturities extending into the post-2030 period.

Historical precedent suggests monitoring congressional activity in 2028–2029 regarding SALT extension could provide early signals for market participants. If extension is signaled early, the 2030 reversion will be priced smoothly. If extension is uncertain, as observed during the 2017 TCJA debate, long-maturity muni spreads may widen 20–30 basis points 6–12 months prior based on DWU's regression model of 2017–2018 spread movements as investors reduce duration exposure.

Issuer Opportunities: Using Demand While Demand Is High

Historical data shows issuers with large infrastructure needs have accessed markets with average new-issue spreads of 65 basis points during 2024-2025 (Bloomberg) supported by 65% institutional ownership and current spreads. The SALT cap sunset has affected relative value calculations across the muni market. Data from 2025 OBBBA debates suggests deferral to 2028 or later correlated with 50 basis points wider spreads if SALT extension becomes uncertain.

Summary: SALT Expansion as a Municipal Bond Market Supporting Factor

Preservation of municipal bond tax exemption per 26 U.S.C. § 103(a) and legislative history of the OBBBA is an important factor in the 2026 muni market. Demand metrics show institutional holdings by insurance companies, banks, and mutual funds at approximately $2.0 trillion across all outstanding munis (Federal Reserve Flow of Funds, Q4 2025), with supply/demand gap analysis (Refinitiv model, 2026) showing absorption of 2026 supply projections of $600B with spreads of 50–75 basis points for investment-grade credits (Bloomberg Municipal Index, Q1 2026). However, relative value has shifted for high-income households in high-tax states: the marginal tax-exemption benefit has compressed as larger SALT deductions would reduce the federal tax rate savings from municipal bond tax exemption if such changes were enacted. Based on projections of $600-750 billion supply and $2.0 trillion institutional capacity, the market absorption occurs at current spreads of 50–75 basis points, assuming no major tax changes and assuming 5% supply growth with 3% demand elasticity (Refinitiv model), with congressional signaling on SALT extension around 2028–2029 a key factor for 2030+ muni demand given potential future changes to the SALT deduction.