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 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.
The One Big Beautiful Bill Act (OBBBA), enacted in 2025, addressed key municipal bond policy questions: it preserved the federal tax exemption for municipal bonds under 26 U.S.C. § 103(a), including qualified private activity bonds; extended the TCJA individual tax rate schedule; and modified the SALT deduction cap established by the TCJA. These provisions collectively shape the tax-equivalent yield calculus and demand dynamics analyzed below.
SALT Cap Expansion: Mechanics and Timing
The TCJA imposed a $10,000 SALT deduction cap for tax years 2018–2025 (enacted December 22, 2017). The OBBBA, enacted in 2025, modified the SALT deduction framework as part of broader tax policy changes affecting municipal bond markets.
Under the TCJA (2018–2025), married couples filing jointly in California, New York, and New Jersey were limited to $10,000 in combined state and local property, income, and sales tax deductions. The OBBBA's modifications to this framework affect the effective federal subsidy for state and local taxation for households in the top income brackets, as analyzed below.
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
The Federal Reserve Flow of Funds data (Q4 2024) identifies two countervailing effects on muni demand from SALT policy changes:
Demand Headwind: 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 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 high-income households in high-SALT states (NY, CA) remained stable at flows within ±5% of trailing four-quarter average during Q4 2024–Q1 2025, among households whose federal tax rates remain elevated even with SALT deduction benefits (Federal Reserve Flow of Funds, household sector, Q4 2024–Q1 2025).
Relative Value: Taxable vs. Municipal Bonds
The nominal tax-exemption value has compressed by approximately 18 basis points for a household with a 35% effective federal tax rate. A municipal bond yielding 3.5% is equivalent to a taxable bond yielding approximately 5.38% for a household with a 35% effective federal tax rate (using the tax-equivalent yield formula: yield ÷ (1 - tax rate) = 3.5% ÷ 0.65 = 5.38%; this simplification ignores net investment income tax and state taxes). Without SALT expansion, the same household faces a higher effective federal tax rate—approximately 37%—because fewer state and local tax deductions are available, producing a 5.56% equivalent taxable yield. Note that SALT deductions affect effective tax rates by reducing taxable income but generally do not change the marginal tax bracket for high earners; the effective rate illustration here shows the directional impact of SALT policy on muni relative value.
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.
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 (SIFMA Outlook, 2026).
Supply drivers include:
- Infrastructure Needs: IIJA authorized $550 billion in new federal investment across transportation, water, broadband, and energy programs (FY2022–2026), with local match requirements ranging from 10% to 20% across transportation, water, and broadband program categories (IIJA program requirements, FY2022–2026), as proposed federal budget cuts threaten to reduce federal grant percentages.
- Cost Inflation: Construction costs rose 8.7% annually for non-residential projects (Associated Builders and Contractors, 2025), requiring proportionally larger bond issues to fund equivalent project scope.
- 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 issuance at $400 billion (2026), driven by IIJA pipeline requirements and deferred maintenance backlogs (SIFMA, 2026).
Credit Implications for Issuers: Refinancing Window Narrowing
Interest rates rose from 1–2% (2020–2021 issues) to 3–4% (2026 refinancings, Bloomberg Municipal Index), increasing refinancing costs by 20–30 basis points for issuers with revenue growth below 2% annually (DWU Refunding Analysis, 2026). However, according to Janney Fixed Income Monthly (Jan 2026), preserved municipal bond tax exemption supports the tax-equivalent yield advantage for 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); the 2017 TCJA debate period provides a historical analog in which short-term muni yields declined while long-term yields remained at or above pre-debate levels. Current curve shape reflects:
- 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. Service revenue bonds (water/sewer/electric) maintained spreads within ±10 bps of pre-TCJA levels during 2018–2025 (Bloomberg Municipal Index), indicating minimal sensitivity to SALT policy changes over the period.
GO Bonds from Strong-Credit States: 12 states in NASBO's 2025 survey with rainy-day funds exceeding 10% of expenditures and diversified economies maintained GO spreads within their 2024–25 historical range (NASBO, S&P, Bloomberg Index), supported by tax-aware investors.
Losers
Lower Investment-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)
Higher-Coupon Bonds from Lower-Rated 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) reflects limited price sensitivity to SALT changes. Lower-rated credits (BBB and below) traded at spreads 90–120 basis points wider than AA-rated peers (Bloomberg, Dec 2025).
Tax Planning Integration: SALT, AMT, and Net Investment Income Tax
Investors may integrate SALT planning with tax strategies. High-income households may consider adjusting muni duration for tax planning purposes, using yield curves and relative value metrics to balance after-tax returns across asset classes. 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 reduce overall federal tax liability — a consideration particularly relevant in elevated-SALT states where effective tax rates shift with SALT policy changes.
2030 Reversion Risk: Investor and Issuer Implications
Any future changes to the SALT cap would be a variable affecting muni spread volatility through 2030. 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 any 2030 SALT policy transition would affect pricing of bonds with maturities extending into the post-2030 period, consistent with the 6–12 month repricing patterns observed during the 2017 TCJA debate (DWU regression analysis, 2017–2018 spread data).
Historical precedent from the 2017 TCJA debate shows that congressional activity signals market repricing 6–12 months in advance; monitoring 2028–2029 SALT extension discussions provides early market signals. 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 widened 20–30 basis points 6–12 months prior in DWU's regression analysis 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. DWU spread analysis during the 2025 OBBBA legislative debate showed that scenarios with deferred SALT extension to 2028 or later correlated with spreads 50 basis points wider for long-maturity munis if extension remained 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 supports the tax-equivalent yield advantage for 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.