Municipal bonds are becoming concentrated in a fewer number of hands and that may not be good for bondholders and states and local governments.

The share of households owning muni bonds fell by almost half between 1989 and 2013 to 2.4 percent from 4.6 percent as the focus of their investing has shifted to tax-deferred retirement accounts such as 401(k) plans, according to a paper by faculty from Brandeis University and the Massachusetts Institute of Technology.

At the same time, the securities are increasingly concentrated among the wealthiest households. The share of total muni bonds held by the wealthiest 0.5 percent of households rose to 42 percent from 24 percent, according to the paper.

The drop in ownership could weaken the political will of municipalities to pay their debt and of Congress to maintain the tax-exemption of municipal bonds, write Daniel Bergstresser, an associate professor of finance at the Brandeis International Business School, and Randolph Cohen, a senior lecturer at MIT’s Sloan School of Management.

“A declining share of households who hold municipal bonds and perceive themselves as benefiting from the tax exemption may place this exemption on a shakier political foundation,” they write in a paper presented this week at the 5th Annual Municipal Finance Conference hosted by the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy.

Annual Consternation

Proposals to eliminate or curtail the $3.7 trillion municipal market’s tax break are a perennial, if little-noticed, feature of Washington, D.C., budget and tax debates. A 35-page plan released by House Speaker Paul Ryan last month that referred to repealing several “special-interest carve-outs” from the tax code without naming them was enough to raise alarm bells with lobbying groups representing local finance officials and investment banks.

Both the Republican chairman of the House Ways and Means Committee and President Barack Obama have previously proposed limiting the tax-exemption.

Representatives of the National Association of State Treasurers, the Bond Dealers of America and the Government Finance Officers Association questioned the paper’s conclusion saying it ignored a vital constituency for the tax exemption: states and local governments that save billions of dollars in financing costs for roads, sewers, schools, and airports. Curtailing the tax exemption would raise state and local government financing costs by $17 billion, according to Washington State Treasurer James McIntire, president of the state treasurers group.

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