California Municipal Bond ETFs Not Worth Risk

NEW YORK ( ETF Expert) -- How does the state of California intend to combat its exorbitant debts? Left-leaning leaders have proposed higher income taxes on the "rich" as well as increasing sales taxes.

Unfortunately, California already sits near the top of the country's taxation ladder. At present, top marginal bracket payers are shelling out nearly 10% -- close to three times the national average.

State corporate tax rates are approximately twice the national average at 8.84%. In fact, wherever one looks -- property, gasoline, sales -- the tax rates may be higher than anywhere else in the nation.

So why would anyone with money stick around California to experience additional fleecing? It doesn't appear that they are.

Arthur Laffer, widely recognized for his work on the Laffer Curve, recently pointed out that California witnessed a net loss of nearly 900,000 tax filers between 1992 and 2008. Even scarier, it isn't known how many productive tax filers left the state during the economic meltdown and tepid recovery period circa 2008-2011.

What is known is that more working adults have left California than have entered the cash-strapped state, reducing the size of the tax base. Additionally, those who exited are/were 14% wealthier (on average) than those who came in.

Simply put, the California government is not able to tax as many people let alone tax as many wealthy people. The better earners and entrepreneurs -- many of whom indeed have a choice with respect to residency -- are pursuing tax-friendlier environs.

You don't have to take my word for it. The statistics already speak for themselves. Many are planning to relocate to Nevada, Arizona or Utah; others already have; I am mapping out a long-term strategy for limiting my exposure to California taxation.

Granted, some "rich" people will not abandon their roots. Those folks may figure that their problems can be solved through investing in California municipal bond funds. Indeed, California munis have had a remarkable run as of late.

Following are three exchange-traded funds that track California municipal bonds and their percentage gains over the past year.

SPDR Barclays Capital CA Muni Bond ( CXA), up 18.0%

PowerShares Insured California Muni Bond ( PWZ), up 17.2%

iShares S&P CA AMT-Free Muni Bond ( CMF), up 15.0%

By comparison, the S&P 500 SPDR Trust ( SPY) is up 7.5%

Despite those strong returns, I believe it is more sensible for high-net-worth investors to diversify nationally for muni bond exposure. Banking on the general obligation debt of the lowest-rated state in the union alone isn't worthy of the additional tax-free yield.

For instance, an investor in the top federal bracket of 35% can garner an approximate tax-free equivalent yield of 6.8% in PowerShares Insured National Muni ( PZA). He or she might be able to obtain 7.7% in approximate tax-free equivalent yield in PowerShares Insured California Muni. Stretching for the additional yield, however, invites greater price volatility.

What's more, as recently as two years ago, a leading credit-default-swap service ranked California as the 10th most likely government to default, with a 25% probability. Have things in California improved so much over the past two years that the state no longer faces the threat of defaulting on its obligations? Is a U.S. government bailout so entirely certain that one should stretch for the extra percentage point?

My advice? Stick with national muni ETFs such as PZA or iShares S&P National AMT-Free Muni ( MUB).

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Disclosure Statement: ETF Expert is a website that makes the world of ETFs easier to understand. Gary Gordon, Pacific Park Financial and/or its clients may hold positions in ETFs, mutual funds and investment assets mentioned. The commentary does not constitute individualized investment advice. The opinions offered are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationships. You may review additional ETF Expert at the site.

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