Why Taxable Municipal Bonds Outshine Investment-Grade Corporates

Today, that proposition exists in the world of taxable municipal bonds.

Investors often ignore taxable munis in favor of their tax-free sisters. That’s a real shame, considering today, taxable munis could offer a better return potential than traditional corporate bonds. With them, they can find the holy grail of reducing credit risk while still offering a top yield.

When investors think of municipal bonds, they think of tax-free bonds. Muni interest income is generally free from Uncle Sam’s grasp and, in many cases, free from state and local taxes as well. These tax-free bonds form the backbone of the $ 4 trillion+ municipal bond market.

But not all munis are tax-free. There is a small, but growing, segment that falls under the taxable umbrella.

In 1986, the federal government enacted legislation that limited the types of activities states and local governments could fund using tax-exempt municipal bonds. Under President Obama and the Build America Bonds, taxable muni issuance increased significantly. More recently, the ending of municipal bond prefunding and the prohibition on cities, states, and other municipalities issuing tax-free bonds to restructure their existing debts, as a result of the 2017 Tax Cuts & Jobs Act, helped solidify taxable muni growth as a legitimate asset class.

Today, there are more than $830 billion worth of taxable municipal bonds outstanding, and issuance continues to grow- with $38 billion in new taxable munis launched last year alone.

For many investors, the question of “what’s the point?” is probably going through their heads. After all, the appeal of municipal bond investing is the tax-free nature of the interest. Why bother with taxable munis at all?

In this case, the “bother” is the ability to get a high yield with reduced credit risk.

Tax-free munis often have low yields compared to most other fixed-income asset classes due to their tax savings. But because taxable munis don’t have that tax-saving advantage, investors demand more yield to compensate. As such, they often yield more than their tax-free sisters. Currently, the Bloomberg Taxable Municipal Index is yielding a yield of 4.99%. That’s not too bad at all. ¹

What makes it interesting is that the yield is actually equal to the current yield of investment-grade U.S. corporate bonds. That yield gets even better when looking at option-adjusted spreads versus the risk-free rate of return, i.e., treasuries. Right now, average spreads for top-tier bonds are +17.3 bps wider for taxable municipals (63.9 bps vs 46.6 bps) than corporate bonds, according to Nuveen. This chart from the asset manager highlights the difference. In essence, investors are getting a better “yield” in taxable munis when considering callability than with IG corporate bonds.

Source: Nuveen

Therefore, investors are earning a comparable yield to that of investment-grade corporate bonds.

However, the credit quality of the taxable municipal index is actually better than that of the investment-grade corporate bond world. Over 75% of the Bloomberg Taxable Municipal Index is rated AA- or better. This compares to just 10% for the Bloomberg U.S. Corporate Bond Index. The difference in credit quality is due to the way taxable munis obtain their repayment ability.

Taxable munis are often a mix of revenue-backed and, increasingly, general obligation streams. This means they are either backed by the cash flow from an asset such as a city’s sewer system or bridge, or the general taxing authority of a state/city. This combination of revenue streams and a state’s ability to raise taxes to cover its debts provides a stronger credit profile than a company.

This combination of strong yields and high credit quality has historically been beneficial for taxable municipal bonds compared to investment-grade corporate debt in terms of returns. Over the last decade, the taxable municipal sector has achieved a 4.0% annualized total return. This has easily beaten the 2.6% return for investment-grade U.S. corporate debt and the 1.8% return for the broader bond market as well. ²

Overall, taxable munis currently offer higher yields and better credit quality than investment-grade corporate bonds. This provides investors with the real ability to lower their credit risk and get a high yield. The last time taxable munis yielded the same as IG bonds was back in 2021, so investors shouldn’t waste the opportunity.

And to sweeten the pot, taxable doesn’t mean 100% taxable. Taxable munis are often still tax-free when it comes to the issuing states and local taxes. So, while a taxable muni from California would put an investor on the hook for Federal taxes, it still avoids state taxes. This enhances their yields even further when compared to corporate bonds and regular municipal bonds.

Given the surge in taxable muni issuance over the last few years, there are now more of these bonds on the market. However, it’s still challenging to buy and sell them like most municipal bonds. To that end, funds remain the most effective approach.

These funds were selected based on their exposure to the taxable municipal and Build America bond sectors. They are sorted by their YTD total returns, which range from -2.3% to 1.2%. They have expenses ranging from 0.28% to 2.63% and assets under management between $367 million and $ 1.53 billion. They are currently yielding between 4.1% and 10.05%.

Ultimately, taxable muni bonds offer a compelling value for investors seeking to mitigate risk and enhance their returns. Such situations don’t always occur in the investing world, and when they do, portfolios should take advantage of them.

Taxable municipal bonds could be an excellent way for investors to meet the holy grail of investing, decreasing risk while increasing returns. With yields higher than those of corporate bonds and better credit quality, these often-ignored bonds make for an excellent addition to a portfolio.

¹ Nuveen (August 2025). Taxable municipal bonds: sunny side of the street

² Mackay (March 2025). Taxable Municipal Bonds: An Overlooked Asset Class