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Taxable and Tax-Exempt Interest Rates: The Role of Personal and Corporate Tax Rates

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  • Joe Peek and James A. Wilcox.
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Abstract

This paper investigates empirically the effects of personal and corporate taxes on taxable interest rates and on the spread between taxable and tax-exempt rates. Two main sets of results emerge. First, we establish that the effective marginal investors in the Treasury bill market are households, as opposed to tax-exempt institutions or corporations. We find no evidence of corporate tax rate effects on Treasury bill yields. The study is then extended to an examination of the tax-exempt market. The results there contradict the hypothesis that commercial bank arbitrage generally ensures that the taxable-tax-exempt interest rate spread is determined by the corporate tax rate. Our estimates decisively reject the corporate in favor of the personal income tax rate as being the relevant tax rate of the marginal investor in this market as well.

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Bibliographic Info

Paper provided by University of California at Berkeley in its series Research Program in Finance Working Papers with number 146.

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Date of creation: 01 Jan 1985
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Handle: RePEc:ucb:calbrf:146

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Postal: University of California at Berkeley, Berkeley, CA USA
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  1. Hamada, Robert S, 1979. "Financial Theory and Taxation in an Inflationary World: Some Public Policy Issues," Journal of Finance, American Finance Association, vol. 34(2), pages 347-69, May.
  2. Martin Feldstein, 1983. "Inflation, Income Taxes, and the Rate of Interest: A Theoretical Analysis," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 28-43 National Bureau of Economic Research, Inc.
  3. Skelton, Jeffrey L., 1983. "Banks, firms and the relative pricing of tax-exempt and taxable bonds," Journal of Financial Economics, Elsevier, vol. 12(3), pages 343-355, November.
  4. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
  5. James M. Poterba, 1984. "Expected Future Tax Policy and Tax Exempt Bond Yields," Working papers 350, Massachusetts Institute of Technology (MIT), Department of Economics.
  6. Tanzi, Vito, 1980. "Inflationary Expectations, Economic Activity, Taxes, and Interest Rates," American Economic Review, American Economic Association, vol. 70(1), pages 12-21, March.
  7. Peek, Joe, 1982. "Interest Rates, Income Taxes, and Anticipated Inflation," American Economic Review, American Economic Association, vol. 72(5), pages 980-91, December.
  8. Hendershott, Patric H & Koch, Timothy W, 1980. " The Demand for Tax-Exempt Securities by Financial Institutions," Journal of Finance, American Finance Association, vol. 35(3), pages 717-27, June.
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