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State Fiscal Institutions and the U.S. Municipal Bond Market

In: Fiscal Institutions and Fiscal Performance

  • James M. Poterba
  • Kim Rueben

This paper presents new evidence on the effect of state fiscal institutions, particularly balanced-budget rules and restrictions on state debt issuance, on the yields on state general obligation bonds. We analyze information from the Chubb Relative Value Survey, which contains relative tax-exempt yields on the bonds issued by different states over the period 1973-1996. We find that states with tighter anti-deficit rules, and more restrictive provisions on the authority of state legislatures to issue debt, pay lower interest rates on their bonds. The interest rate differential between a state with a very strict anti-deficit fiscal constitution, and one with a lax constitution, is between fifteen and twenty basis points. States with binding revenue limits tend to face higher borrowing rates by approximately the same amount, while states with expenditure limits face lower borrowing costs. Thus fiscal restraints that control expenditures are viewed favorably by bond market participants, while those that restrict taxes, and therefore might interfere with the state's ability to repay interest, result in higher borrowing costs. The effect of strict fiscal institutions is particularly evident when a state's economy is weak. These results provide important evidence that bond market participants consider fiscal institutions in assessing the risk characteristics of tax-exempt bonds, and further support the view that fiscal institutions have real effects on fiscal policy outcomes.

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This chapter was published in:
  • James M. Poterba & J├╝rgen von Hagen, 1999. "Fiscal Institutions and Fiscal Performance," NBER Books, National Bureau of Economic Research, Inc, number pote99-1, May.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 8028.
    Handle: RePEc:nbr:nberch:8028
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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    1. Poterba, James M, 1994. "State Responses to Fiscal Crises: The Effects of Budgetary Institutions and Politics," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 799-821, August.
    2. Bayoumi, Tamim & Eichengreen, Barry, 1994. "Restraining Yourself: Fiscal Rules and Stabilization," CEPR Discussion Papers 1029, C.E.P.R. Discussion Papers.
    3. Lovely, Mary E. & Wasylenko, Michael J., 1992. "State Taxation of Interest Income and Municipal Borrowing Costs," National Tax Journal, National Tax Association, vol. 45(1), pages 37-52, March.
    4. Bayoumi, Tamim & Goldstein, Morris & Woglom, Geoffrey, 1995. "Do Credit Markets Discipline Sovereign Borrowers? Evidence from US States," CEPR Discussion Papers 1088, C.E.P.R. Discussion Papers.
    5. Poterba, J.M., 1989. "Tax Reform And The Market For Tax-Exempt Debt," Working papers 514, Massachusetts Institute of Technology (MIT), Department of Economics.
    6. Metcalf, G.E., 1989. "Federal Taxation And The Supply Of State Debt," Papers 40, Princeton, Woodrow Wilson School - Discussion Paper.
    7. Bunch, Beverly S, 1991. " The Effect of Constitutional Debt Limits on Stage Governments' Use of Public Authorities," Public Choice, Springer, vol. 68(1-3), pages 57-69, January.
    8. Timothy Besley & Anne Case, 1994. "Unnatural Experiments? Estimating the Incidence of Endogenous Policies," NBER Working Papers 4956, National Bureau of Economic Research, Inc.
    9. Matsusaka, John G, 1995. "Fiscal Effects of the Voter Initiative: Evidence from the Last 30 Years," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 587-623, June.
    10. Alberto Alesina & Roberto Perotti, 1996. "Budget Deficits and Budget Institutions," NBER Working Papers 5556, National Bureau of Economic Research, Inc.
    11. Eichengreen, B., 1992. "Should the Maastricht Treaty be Saved?," Princeton Studies in International Economics 74, International Economics Section, Departement of Economics Princeton University,.
    12. Peter Fortune, 1996. "Do municipal bond yields forecast tax policy?," New England Economic Review, Federal Reserve Bank of Boston, issue Sep, pages 29-48.
    13. Capeci, John, 1994. "Local fiscal policies, default risk, and municipal borrowing costs," Journal of Public Economics, Elsevier, vol. 53(1), pages 73-89, January.
    14. James M. Poterba, 1996. "Do Budget Rules Work?," NBER Working Papers 5550, National Bureau of Economic Research, Inc.
    15. Barry Eichengreen and Tamim Bayoumi., 1993. "The Political Economy of Fiscal Restrictions: Implications for Europe from the United States," Center for International and Development Economics Research (CIDER) Working Papers C93-020, University of California at Berkeley.
    16. Ronald J. Shadbegian, 1996. "Do Tax And Expenditure Limitations Affect The Size And Growth Of State Government?," Contemporary Economic Policy, Western Economic Association International, vol. 14(1), pages 22-35, 01.
    17. Robert P. Inman, 1996. "Do Balanced Budget Rules Work? U.S. Experience and Possible Lessons for the EMU," NBER Working Papers 5838, National Bureau of Economic Research, Inc.
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