The midterm election could reshape the muni bond market. Here’s what investors need to know

The outcome of Tuesday's election is expected to have broad implications across the market, including municipal bonds.

The spotlight has been on the battle for congressional control and whether Democrats will wrest the House of Representatives, the Senate or both from Republicans. But for the muni market, what happens at the state level could have bigger repercussions — at least in the near term.

There is an array of initiatives on ballots around the nation that could change tax laws and add to bond supply. Taxes matter to muni investors since the income received is free of federal tax, as well as state tax if the holder lives in the state where the bond is issued.

Depending on the location, ballot measures are up for approval that would either provide tax breaks, or raise taxes on the wealthy.

"It's a complete bifurcation between red and blue states," said Dan Close, head of municipals at Nuveen. "Blue states are trying to put in place graduated income tax structures, trying to capture more revenue from high-income earners. Red states are promoting affordability by trying to cut property taxes."

Red states are those that predominantly vote Republican, while blue states swing toward Democrats.

For instance, California has a proposition known as the " billionaire tax ," which would impose a one-time levy equal to 5% of the wealth of certain taxpayers with at least $1 billion in assets. The state also has a measure on the ballot that would make a temporary tax hike permanent on individuals earning over $371,000, adjusted annually for inflation. The tax is currently set to expire in 2031.

"The impact to the muni bond market will be to make the exemption more valuable," Close said of the possible passage of tax increases. Investors will likely seek shelter in the muni market, which would send bond prices higher, he noted.

It is a different story in Florida, where voters are set to decide whether to increase the Sunshine State's homestead exemption for non-school district property taxes. Qualified homeowners currently have a $25,000 property tax exemption, as well as another for $25,000 that doesn't apply to school property taxes. The new proposal raises the latter exemption to $150,000 in 2027 and $250,000 by 2028. New residents have a five-year waiting period before receiving the benefit.

If passed, some local governments will have to find other revenue sources or increase the overall tax rate to replace what they've lost, said Tom Kozlik, head of public policy and municipal strategy at HilltopSecurities.