Of the sweeping changes introduced by the federal budget, entitlement and tax reforms stand out in the municipal market. Credit selection remains key as pressures mount, although delayed implementation provides some runway.
On July 4, 2025, President Trump signed into law the One Big Beautiful Bill Act (OBBBA). The legislation fulfills many of the administration’s campaign promises, including tax deductions for tips and overtime, the permanent extension of personal income tax rates established in 2017, and an increase to the state and local income tax (SALT) deduction. Not surprisingly, the bill has implications for the municipal market. First and foremost, it preserves the tax exemption of municipal bonds as we had anticipated and despite suggestions that it might be eliminated to address the deficit. Others are less favorable and are outlined below. As headwinds increase, active management driven by a rigorous research process is more important than ever. It is precisely the strength of our research team that allows us to continue to identify durable and attractive investment opportunities for our clients.
Healthcare: High
The bill reduces federal Medicaid spending by $1 trillion over ten years by imposing work requirements for adults, increasing eligibility checks, implementing co-pays for some, and reducing federal matching dollars. The Congressional Budget Office (CBO) estimates that at least 12 million people will lose coverage nationwide. The uninsured generally continue to seek care and often fail to pay for services, hurting hospitals’ margins. Hospitals with large Medicaid patient bases are most exposed. Favorably, some changes are phased in over multiple years, allowing providers time to adjust, and the bill includes a $50 billion fund for rural health providers that may ease the transition. We have consistently favored health systems with higher reliance on commercially insured patients, a track record of positive margins, and strong balance sheets.
States: Moderate
States will also contend with Medicaid changes as they will have to decide if and how they make up for federal revenue loss. For the first time, the federal food assistance program known as SNAP will share costs with states. On the revenue front, states stand to lose from tax incentives that allow businesses to fully expense research and development costs. Effects will vary by state, but the CBO estimates that 27 states and the District of Columbia could jointly lose $11 billion annually. Other policy items could be modestly positive for state budgets, like increased immigration enforcement. Another CBO study indicates that the immigration surge of 2021-2023 resulted in a net cost to states and local governments of $10 billion. More importantly, states are semi-sovereign in nature, with the flexibility to raise revenue by increasing taxes and the ability to cut back on expenditures elsewhere if needed.
Higher Education: Low
The OBBBA places restrictions on and increases the costs of student loans which could limit access and affect enrollment. It also increases the endowment tax from 1.4% to as much as 8% for wealthy colleges, with exemptions for smaller institutions.
While the preservation of the municipal tax exemption is an important win for our market, in aggregate these changes will challenge municipal credit quality. The federal government, which has historically been supportive of states and local governments is now decidedly less so. Municipal credit quality is currently near its highwater mark as reserves are flush with the revenue growth of the post-pandemic years and economic activity remains strong. However, within this new paradigm, a research-driven approach to active management is paramount.
Finally, we would be remiss if we did not highlight the opportunities in our market. Nominal yields remain attractive, particularly on the long end. Looking ahead, we anticipate ample buying opportunities based on expectations for increased issuance and positive net supply. We also expect unpredictable federal policy to persist, creating pockets of spread widening and attractive entry points.
The OBBBA represents a marked change in federal policy and creates headwinds for key sectors. Our disciplined investment process underpinned by top tier research has allowed us to proactively rebalance and will remain paramount as we continue to identify investment opportunities.