Working Paper: NBER ID: w1599
Authors: Roger H. Gordon; Joel Slemrod
Abstract: Current U.S. tax law creates a variety of incentives affecting municipal financial policy. Under current law,municipalities can borrow at a tax-exempt interest rate yet can earn the full market rate of return on any assets held. Residents, in contrast, if they borrow or lend as individuals,pay or earn the market rate of return but after personal income taxes. These differences in rates of return create a variety of arbitrage opportunities, allowing communities/residents to borrow at low rates and invest at higher rates.The purpose of this paper is to examine empirically the financial policy of municipalities in four states (Connecticut, Maine, Massachusetts and Rhode Island) to see to what degree these municipalities attempt to take advantage of each of the available opportunities to engage in tax arbitrage. Our datacomes from the 1980 U.S. Census of Population and Housing, and the 1977 U.S.Census of Governments. We find clear evidence that communities do actively engage in such tax arbitrage.
Keywords: municipal finance; tax arbitrage; tax policy
JEL Codes: H71; H72
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| marginal tax rates (H29) | municipal borrowing (H74) |
| community characteristics (R23) | financial policy (E60) |
| tax arbitrage (H26) | arbitrage profit (F16) |
| wealthier communities (I39) | municipal investment behavior (H74) |