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State Income Tax Changes and the Demand for Municipal Bond Funds

Author

Listed:
  • Jon A. Fulkerson

    (University of Dayton, Dayton, OH, USA)

  • Nancy L. Haskell

    (University of Dayton, Dayton, OH, USA)

Abstract

We consider how state income tax changes affect the demand for municipal bonds by in-state investors. A tax increase (decrease) makes investing in municipal bonds more (less) desirable, and theory predicts a change in demand by investors until the yields on municipal bonds reach a new equilibrium. Using a sample of state-specific municipal bond funds, we find states with tax decreases have net outflows in the following year of approximately 2% per percentage point drop in tax rates, while tax increases lead to inflows around 1.58%. We find that the response to tax changes is not the immediate reallocation predicted in perfect markets with no frictions.

Suggested Citation

  • Jon A. Fulkerson & Nancy L. Haskell, 2021. "State Income Tax Changes and the Demand for Municipal Bond Funds," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 11(04), pages 1-35, December.
    • Handle: RePEc:wsi:qjfxxx:v:11:y:2021:i:04:n:s2010139221500166
    DOI: 10.1142/S2010139221500166
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