During last year's tax negotiations, ending the federal tax exemption on municipal bond interest was seriously discussed as a way to raise revenue. It did not make the final law. The exemption came through intact, mayors and county officials went back to their day jobs, and the story left the front page.
The market did not fully go back. Long-dated municipals repriced during the scare as though the exemption were already gone, and much of that steepness is still sitting in the curve. Prices moved on tax policy risk rather than on anything happening to the credit quality of the issuers, and that gap has not entirely closed.
What the exemption is actually worth
Interest on most municipal bonds is exempt from federal income tax, which means a muni yield has to be compared with a Treasury yield on an after-tax basis to mean anything. In midsummer, 30-year AAA municipals yielded about 4.32%. For an investor in the top federal bracket, that is equivalent to a taxable yield above 7%.
That comparison is the entire reason the asset class exists at the size it does. Remove the exemption and states and cities would have to offer taxable-equivalent yields to attract the same buyers, which raises their borrowing costs on everything from school construction to water systems. The proposal was never really about bondholders; it was about shifting a federal subsidy, and the borrowing costs would have landed on local budgets.
For an investor, the mechanical consequence is that a muni's attractiveness depends on the holder's tax bracket in a way no other fixed income asset does. The same bond can be clearly cheap for one buyer and clearly expensive for another, which is unusual and worth remembering when comparing headline yields.
A steeper curve than Treasuries offer
Whitmore's Watchlist:
MUB (iShares National Muni Bond ETF): Broad investment-grade municipal exposure, the standard benchmark for the asset class.
VTEB (Vanguard Tax-Exempt Bond ETF): The same broad exposure at a lower expense ratio, which compounds meaningfully over long holding periods.
HYD (VanEck High Yield Muni ETF): Lower-rated municipal credit, where the extra yield comes with real issuer-specific risk rather than only duration.
The muni curve from two years out to thirty was recently around 189 basis points steep, against roughly 89 basis points for the equivalent stretch of the Treasury curve. Investors are being paid substantially more to extend maturity in municipals than in governments.
Supply explains part of it. Issuance ran about $595 billion in 2025 and is tracking toward $600 billion or more this year, which would be a record. States and cities are borrowing heavily for infrastructure at the same time as the long end of every bond market is demanding a higher term premium, and the 30-year Treasury touched its highest level in 19 years last month.
Duration is doing the same work in both markets, but the tax treatment changes what an investor keeps at the end of it. A steep curve rewards patience, and in municipals that reward is measured after tax, which is why the shape of this curve draws a different crowd than the Treasury curve does.
The rest is residual policy risk. A threat that was raised once and defeated can be raised again in a future budget negotiation, and the market appears to be holding back a small discount against that possibility.
Credit versus policy
The distinction worth keeping straight is that none of this reflects deteriorating municipal finances. State and local balance sheets came through the past few years in reasonable shape, reserves are generally healthy, and default rates in investment-grade municipals remain very low by comparison with corporate credit.
Sector matters more than the aggregate here. General obligation debt backed by broad taxing power behaves differently from revenue bonds tied to a single hospital system, airport or toll road, and the gap between them widens when the economy slows. That is the risk an investor is actually paid for in municipals, and it is specific to the issuer rather than to the market.
What is being priced is the durability of a tax provision, which is a different risk from whether a school district can pay. Those two risks can move independently, and right now they are.
Whitmore's Take: When a market reprices on policy fear and the policy does not change, the dislocation is worth understanding rather than assuming it will simply correct. Municipals are one of the few places where the right answer genuinely depends on your own tax situation.
Written by Daniel Whitmore
Millionaire Insiders