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The Role of Federal Taxation in the Supply of Municipal Bonds: Evidence From Municipal Governments

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  • Gilbert E. Metcalf

Abstract

This paper considers ways in which federal tax policy affects municipal asset and debt holdings. The tax treatment of municipal bonds and income creates an arbitrage opportunity for communities to issue tax exempt debt and invest in financial assets. I present evidence that suggests the rules in effect prior to 1986 to prevent this activity were not effective. I then develop and estimate a model of municipal bond supply. I find a semi-elasticity of 1.23 of long term debt with respect to the spread between the after tax rate of return and the municipal borrowing rate.

Suggested Citation

  • Gilbert E. Metcalf, 1991. "The Role of Federal Taxation in the Supply of Municipal Bonds: Evidence From Municipal Governments," NBER Working Papers 3891, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3891
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    1. Douglas Holtz-Eakin & Harvey S . Rosen, 1988. "Tax Deductibility and Municipal Budget Structure," NBER Chapters, in: Fiscal Federalism: Quantitative Studies, pages 107-136, National Bureau of Economic Research, Inc.
    2. Metcalf, Gilbert E., 1993. "Federal taxation and the supply of state debt," Journal of Public Economics, Elsevier, vol. 51(3), pages 269-285, July.
    3. Roger H. Gordon & Joel B. Slemrod, 1986. "An Empirical Examination of Municipal Financial Policy," NBER Chapters, in: Studies in State and Local Public Finance, pages 53-82, National Bureau of Economic Research, Inc.
    4. Alan J. Auerbach, 1985. "Real Determinants of Corporate Leverage," NBER Chapters, in: Corporate Capital Structures in the United States, pages 301-324, National Bureau of Economic Research, Inc.
    5. Metcalf, Gilbert E, 1990. "Arbitrage and the Savings Behavior of State Governments," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 390-396, August.
    6. Poterba, James M., 1989. "Tax reform and the market for tax-exempt debt," Regional Science and Urban Economics, Elsevier, vol. 19(3), pages 537-562, August.
    7. Harvey S. Rosen, 1988. "Fiscal Federalism: Quantitative Studies," NBER Books, National Bureau of Economic Research, Inc, number rose88-1.
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    Cited by:

    1. Thomas Luke Spreen & Ed Gerrish, 2022. "Taxes and tax‐exempt bonds: A literature review," Journal of Economic Surveys, Wiley Blackwell, vol. 36(4), pages 767-808, September.
    2. Fortune, Peter, 1998. "Tax-Exempt Bonds Really Do Subsidize Municipal Capital!," National Tax Journal, National Tax Association;National Tax Journal, vol. 51(1), pages 43-54, March.
    3. Peter Fortune, 1995. "Debt capacity, tax exemption, and the municipal cost of capital: a reassessment of the new view," Working Papers 95-8, Federal Reserve Bank of Boston.
    4. Edward V. Regan, "undated". "A New Approach to Tax-Exempt Bonds, Infrastructure: Financing with the AGIS Bond," Economics Public Policy Brief Archive ppb_58, Levy Economics Institute.
    5. H. Youn Kim & Junsoo Lee & Stephen E. Lile & James R. Ramsey, 2000. "Municipal Bonds and Tax Arbitrage: A Cointegration Analysis," Public Finance Review, , vol. 28(4), pages 372-389, July.
    6. James Alm & Trey Dronyk‐Trosper, 2021. "What drives road infrastructure spending?," Public Budgeting & Finance, Wiley Blackwell, vol. 41(4), pages 20-49, December.
    7. Randall W. Eberts & William F. Fox, 1992. "The Effect of Federal Policies On Local Public Infrastructure Investment," Public Finance Review, , vol. 20(4), pages 557-571, October.
    8. Gilbert E. Metcalf, 1993. "Tax exporting, federal deductibility, and state tax structure," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 12(1), pages 109-126.
    9. Robert P. Inman, 1993. "Presidential Leadership and the Reform of Fiscal Policy: Learning from Reagan's Role in TRA 86," NBER Working Papers 4395, National Bureau of Economic Research, Inc.
    10. M.S. Tumanggor, 2020. "Issuance of Municipal Bonds through Capital Markets as Financial Revenue for Regional Development," International Journal of Economics & Business Administration (IJEBA), International Journal of Economics & Business Administration (IJEBA), vol. 0(3), pages 326-334.

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