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An Empirical Examination of Municipal Financial Policy

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  • 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.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1599.

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Date of creation: Apr 1985
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Publication status: published as Gordon, Roger H. and Joel Slemrod. "An Empirical Examination of Municipal Financial Policy." State and Local Public Finance, edited by Harvey S. Rosen. Chicago: UCP, 1986, pp. 53-78.
Handle: RePEc:nbr:nberwo:1599

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  1. Irwin Tepper, 1981. "Taxation and Corporate Pension Policy," NBER Working Papers 0661, National Bureau of Economic Research, Inc.
  2. Roger H. Gordon, 1982. "Interest Rates, Inflation, and Corporate Financial Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 13(2), pages 461-491.
  3. Gordon, Roger H & Slemrod, Joel, 1983. " A General Equilibrium Simulation Study of Subsidies to Municipal Expenditures," Journal of Finance, American Finance Association, vol. 38(2), pages 585-94, May.
  4. Tepper, Irwin, 1981. "Taxation and Corporate Pension Policy," Journal of Finance, American Finance Association, vol. 36(1), pages 1-13, March.
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Cited by:
  1. James M. Poterba & Arturo Ramirez Verdugo, 2008. "Portfolio Substitution and the Revenue Cost of Exempting State and Local Government Interest Payments from Federal Income Tax," NBER Working Papers 14439, 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. Metcalf, Gilbert E, 1990. "Arbitrage and the Savings Behavior of State Governments," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 390-96, August.
  4. Charles R. Hulten & Robert M. Schwab, 1987. "Income Originating in the State and Local Sector," NBER Working Papers 2314, National Bureau of Economic Research, Inc.
  5. James M. Poterba, 1989. "Tax Reform and the Market For Tax-Exempt Debt," NBER Working Papers 2900, National Bureau of Economic Research, Inc.
  6. Robert P. Inman, 1985. "Does Deductibility Influence Local Taxation?," NBER Working Papers 1714, National Bureau of Economic Research, Inc.

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