Tax Hike to Help Municipal Bonds

THE municipal bond market is holding steady, despite more and more bonds being put on credit watches in areas facing fiscal difficulties such as New York City and Philadelphia. Moreover, anticipated changes in the United States tax code - with Congress and the White House expected to boost the highest marginal tax rate to help offset the federal budget deficit - could provide a boost for municipal bonds, experts say. The highest marginal tax rate is 28 percent, but is likely to be lifted to at least 31 percent for upper-income Americans.

``Municipal bonds have been staying relatively firm on the prospects of higher tax rates,'' says Arnold Kaufman, a vice president at Standard & Poor's, and editor of S & P's Outlook, a market report. ``The yield gap between municipal bonds and US government Treasury issues has narrowed somewhat in recent months, which makes the municipals slightly less attractive on a pure-yield basis. But when you factor in the issue of the tax exemption, the municipal bonds become fairly attractive.'' Tax-free investment

Municipal bonds are issued by state and local governmental agencies; depending on the bonds, they are often free of both federal and state - and, in some cases, local - tax obligations. So far this year, the number of municipal obligations has fallen to slightly over 6,000 bond issues, down from slightly over 7,000 issues last year. But despite a dip in the number of issues, the dollar volume of the municipal obligations is actually up from last year, says John Allan, editor of The Bond Buyer, a daily market publication.

Through Oct. 19, long-term obligations worth $97.6 billion have been sold, compared to issues worth $94.9 billion for the same period last year.

Muni-bond prices have fallen in some areas, reflecting concerns about slowdowns in local economies. ``But by and large, the municipal bond market is fairly strong,'' Mr. Allan says.

The average yield on the bond index monitored by The Bond Buyer is now at 7.7 percent, although bonds issued by such jurisdictions as New York, Philadelphia, and Massachusetts have been running between 8 and 9 percent, reflecting their higher degree of risk.

A tax-free yield of 7.7 percent equals a taxable yield of 10.7 percent if the marginal tax rate is at 28 percent. A tax-free yield of 7.7 percent would equal a taxable yield of 11.2 percent if the marginal tax rate is 31 percent. Muni-bond assets are up

For most individuals who have less than $100,000 to invest, buying municipal issues directly - that is, owning actual bonds - makes little sense, says Hyman Grossman, a managing director and bond expert with Standard & Poor's. Bonds are fairly expensive, usually selling in units of $5,000 or more. And commission and transactions costs tend to eat up whatever tax advantages might accrue to an individual in a lower income bracket, he says.

Thus, he argues, most individuals interested in municipal issues should buy into a well-established mutual fund.

Assets of municipal bond funds have been increasing lately, says Erick Kanter, a spokesman for the Investment Company Institute in Washington. Total assets of the national municipal bond funds monitored by the ICI reached $67.4 billion at the end of August, up from $61.4 billion for in August, 1989. Assets of single-state municipal bond funds were also up, reaching $46.1 billion at the end of August, 1990. That compares to total assets of $38.6 billion for August in 1989. Relatively risk-free

Despite public concerns about safety, municipal bonds are relatively free of risk, at least compared to corporate bonds or junk bonds, Allan says. Indeed, defaults on muni-bonds amounted to less than 1 percent of the face value of all municipals issued in the last 10 years, according to a recent analysis by IDS Financial Services, based in Minneapolis.

Moreover, many muni-bonds are now covered by insurance, which means that interest and principle payments will be met in a timely manner.

Still, not all experts are sanguine about the future of muni-bonds, given the slowdown in the economy, and declining tax revenues in local jurisdictions.

One immediate concern: Could insurance firms underwriting municipals be overwhelmed by a series of possible defaults?