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Tax Advantages and Imperfect Competition in Auctions for Municipal Bonds

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  • 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 behaviour 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 analyse a recent non-tax regulation that affects entry into municipal bond auctions.

Suggested Citation

  • Daniel Garrett & Andrey Ordin & James W Roberts & Juan Carlos Suárez Serrato, 2023. "Tax Advantages and Imperfect Competition in Auctions for Municipal Bonds," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 90(2), pages 815-851.
  • Handle: RePEc:oup:restud:v:90:y:2023:i:2:p:815-851.
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    File URL: http://hdl.handle.net/10.1093/restud/rdac035
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    Cited by:

    1. Dario Cestau & Burton Hollifield & Dan Li & Norman Schürhoff, 2019. "Municipal Bond Markets," Annual Review of Financial Economics, Annual Reviews, vol. 11(1), pages 65-84, December.
    2. Baridhi Malakar, 2024. "Essays on Responsible and Sustainable Finance," Papers 2406.12995, arXiv.org.
    3. Lu, Runjing & Ye, Zihan, 2023. "Roe v. Rates: Reproductive Healthcare and Public Financing Costs," SocArXiv 7t5jz, Center for Open Science.

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    More about this item

    Keywords

    Auctions; Imperfect competition; Municipal bonds; Pass-through; Taxes;
    All these keywords.

    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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