Working Paper: NBER ID: w1469
Authors: James M. Poterba
Abstract: This paper tests several competing models of municipal bond market equilibrium. It analyzes the influence of changes in both personal and corporate tax reforms on the yield spread between taxable and tax-exempt interest rates. The findings suggest that changes in personal income tax rates have pronounced effects on long-term municipal interest rates, but small effects on short-maturity yields. Corporate tax reforms, however, affect both long- and short-term yields. These results are inconsistent with the view that the relative yields on taxable and tax-exempt bonds are set by banks and insurance companies which are taxed at the corporate rate. They support the more traditional view that banks are the primary holders of short-term muncipal securities, while households are the principal investors in the long-term municipal market. This view suggests that proposals to reform municipal financing policies by increasing the use of short-term borrowing, or issuing long-term floating-rate debt, could reduce the real cost of municipal borrowing.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Personal Tax Changes (H24) | Long-term Municipal Interest Rates (E43) |
| Corporate Tax Reforms (H29) | Yield Spread (Long and Short-term) (E43) |
| Expected Tax Changes (H29) | Yield Spread (E43) |
| Corporate Tax Reforms (H29) | Short-term Yields (E43) |