Working Paper: NBER ID: w23473
Authors: Daniel Garrett; Andrey Ordin; James W. Roberts; Juan Carlos Suárez Serrato
Abstract: We study the interaction between tax advantages for municipal bonds and the market structure of auctions for these bonds. We show that this interaction can limit a bidder’s ability to extract information rents and is a crucial determinant of state and local governments’ borrowing costs. Reduced-form estimates show that increasing the tax advantage by 3 pp lowers mean borrowing costs by 9-10%. We estimate a structural auction model to measure markups and to illustrate and quantify how the interaction between tax policy and bidder strategic behavior determines the impact of tax advantages on municipal borrowing costs. We use the estimated model to evaluate the efficiency of Obama and Trump administration policies that limit the tax advantage for municipal bonds. Because reductions in the tax advantage inflate bidder markups and depress competition, the resulting increase in municipal borrowing costs more than offsets the tax savings to the government. Finally, we use the model to analyze a recent non-tax regulation that affects entry into municipal bond auctions.
Keywords: municipal bonds; tax advantages; auctions; borrowing costs
JEL Codes: D44; H71; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Personal income tax subsidy increase (H24) | Decrease in borrowing costs (G21) |
| 3 pp increase in personal income tax subsidy (H24) | Decrease in borrowing costs (G21) |
| Tax advantages (H25) | Increase in auction participation (D44) |
| Tax advantages (H25) | Influence on borrowing costs through auction competitiveness (D44) |