By Cathy Carlson of ETF DatabaseIn the past two weeks, many large U.S. corporations have posted solid earnings which has sparked optimism over an economic recovery. However, recent testimony from Fed Chair Ben Bernanke has weighed on the markets and has kept many investors fearful about the near future. In his testimony, Bernanke called the American economic outlook 'unusually uncertain' and said that several tools were being discussed in order to help boost the economy. This gloomy proposition left many certain that a double dip was around the corner which has placed an extremely heavy burden on the federal government in order to quickly revive the economy before the November elections while simultaneously keeping the ever-increasing budget deficits in check. As a way to cut back on this deficit while keeping the vast majority of the electorate satisfied, legislators are discussing the possibility of allowing the now infamous "Bush tax cuts" to expire for taxpayers that have an income of $250,000 or more. If the cuts are allowed to expire, the top individual tax rate would raise from 35% to 39.4% next year and many investors could see increased rates on capital gains and dividends as well. While president Barack Obama supports the plan to increase the taxes on these wealthy individuals back to 39.4%, he faces stiff opposition from Republicans, small businesses, and even some fellow Democrats. Democratic consensus has been eroding as the economy has remained sluggish, with some in the majority party openly expressing their concerns over raising taxes while facing a grim economic portrait wrought with high levels of unemployment. Republicans also find themselves conflicted, many are unsure of which should take greater priority; the extension of the tax cuts to help boost the economy, or allowing the cuts to expire in order to narrow the budget deficit, which is becoming an increasingly large issue for fiscal conservatives. This is especially true given the immense cost of continuing the tax breaks for high-income individuals; some estimates put the cost to the Federal Government at $115 billion. Due to these high costs and the struggling economy, it is uncertain whether the Bush tax cuts will be allowed to expire for those in the highest tax brackets, however, investors can begin to prepare themselves for increased rates by taking a closer look at the municipal bond market
Municipal bonds are issued by state and local governments to either develop or finance projects such as sewer systems or highways. Since state and local governments cannot print money like the federal government, most investors agree that municipal bonds have a higher default risk than Treasury Bills so they typically provide a higher return to investors as well. For high tax bracket individuals, these securities can also provide an excellent avenue to minimize tax liabilities on the federal level. Often called "tax-free" bonds, munis are exempt from federal taxes so a municipal bond yielding 4% for an investor at a marginal tax rate of 35% would be receiving the equivalent return of a taxable bond yielding 6.15%. However, an investor at a lower tax bracket would fail to see the majority of this tax benefit making these securities more appropriate for high net worth individuals. Below, we highlight three municipal bond funds which can provide high net worth individuals a haven for protecting their funds should tax rates creep higher at the end of the year .