Arbitrage and the Savings Behavior of State Governments
AbstractThe federal tax code creates strong incentives for tax arbitrage activity on the part of state governments. This arbitrage activity is illegal and previous research has typically assumed that the constraint against arbitrage activity is binding. This paper explicitly tests this proposition by considering whether financial asset holdings increase as the yield spread between taxable and tax exempt securities rises. Using a data set on 40 state governments over a 7 year period, I find that there is a significant response to changes in the yield spread. One implication of these results is that the Tax Reform Act of 1986 which made even greater efforts to curb arbitrage activity is likely to be ineffective.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3017.
Date of creation: Jun 1989
Date of revision:
Publication status: published as The Review of Economics and Statistics, Vol. LXXII, No. 3, pp. 390-396, (August 1990).
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Other versions of this item:
- 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.
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