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Do Tax-Exempt Bonds Really Subsidize Municipal Capital?

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  • Roger H. Gordon
  • Gilbert E. Metcalf

Abstract

We argue that the tax-exempt status of municipal bonds provides little or no subsidy to capital investment by communities. Instead, the tax exemption simply provides arbitrage opportunities to high and low tax bracket individuals while leaving individuals in intermediate tax brackets essentially unaffected. We also argue that the revenue cost of the tax exemption is much less than traditionally thought due to the portfolio rebalancing that would occur if the tax exemption were eliminated. Finally, we note that the only way to prevent all municipal arbitrage possibilities would be to pass through municipal interest income and payments to residents for tax purposes.

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File URL: http://www.nber.org/papers/w3835.pdf
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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3835.

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Date of creation: Sep 1991
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Publication status: published as National Tax Journal, Volume XLIV, No. 4, Part 1, December 1991. Cambridge: The MIT Press. Available through NBER.
Handle: RePEc:nbr:nberwo:3835

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Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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Web page: http://www.nber.org
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Cited by:
  1. Merle Erickson & Austan Goolsbee & Edward Maydew, 2002. "How Prevalent is Tax Arbitrage? Evidence from the Market for Municipal Bonds," NBER Working Papers 9105, National Bureau of Economic Research, Inc.
  2. Peter Fortune, 1996. "Tax-exempt bonds really do subsidize municipal capital!," Working Papers 96-9, Federal Reserve Bank of Boston.
  3. Edward L. Glaeser, 2012. "Urban Public Finance," NBER Working Papers 18244, National Bureau of Economic Research, Inc.
  4. 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.
  5. Hulten, Charles R. & Schwab, Robert M., 1997. "A fiscal federalism approach to infrastructure policy," Regional Science and Urban Economics, Elsevier, vol. 27(2), pages 139-159, April.
  6. 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.

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