Working Paper: NBER ID: w14496
Authors: Andrew Ang; Vineer Bhansali; Yuhang Xing
Abstract: Implicit tax rates priced in the cross section of municipal bonds are approximately two to three times as high as statutory income tax rates, with implicit tax rates close to 100% using retail trades and above 70% for interdealer trades. These implied tax rates can be identified on the cross section of municipal bonds because a portion of secondary market municipal bond trades involve income taxes. After valuing the tax payments, market discount bonds, which carry income tax liabilities, trade at yields around 25 basis points higher than comparable municipal bonds not subject to any taxes. The high sensitivities of municipal bond prices to tax rates can be traced to individual retail traders dominating dealers and other institutions.
Keywords: municipal bonds; implicit tax rates; market discount bonds; taxation; individual investors
JEL Codes: G12; G28; H20; H24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| implicit tax rates priced into municipal bonds (H74) | municipal bond prices (H74) |
| market discount bonds carry income tax liabilities (G12) | market discount bonds trade at higher yields than fully tax-exempt municipal bonds (H74) |
| individual retail investors dominate the market (G10) | pricing of municipal bonds relative to tax treatment (H74) |
| tax burdens associated with market discount bonds (E43) | yields on market discount bonds (E43) |
| individual tax rates (H26) | cross-sectional pricing of municipal bonds (G12) |
| high yields on market discount bonds among retail trades (E43) | individual investors react strongly to tax liabilities (H32) |