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Expected Future Tax Policy and Tax Exempt Bond Yields

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  • James M. Poterba

Abstract

This paper tests several competing models of municipal bond market equilibrium. It analyzes the influence of changes in both personal and corporate tax reforms on the yield spread between taxable and tax-exempt interest rates. The findings suggest that changes in personal income tax rates have pronounced effects on long-term municipal interest rates, but small effects on short-maturity yields. Corporate tax reforms, however, affect both long- and short-term yields. These results are inconsistent with the view that the relative yields on taxable and tax-exempt bonds are set by banks and insurance companies which are taxed at the corporate rate. They support the more traditional view that banks are the primary holders of short-term muncipal securities, while households are the principal investors in the long-term municipal market. This view suggests that proposals to reform municipal financing policies by increasing the use of short-term borrowing, or issuing long-term floating-rate debt, could reduce the real cost of municipal borrowing.
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Suggested Citation

  • James M. Poterba, 1984. "Expected Future Tax Policy and Tax Exempt Bond Yields," Working papers 350, Massachusetts Institute of Technology (MIT), Department of Economics.
    • Handle: RePEc:mit:worpap:350
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    Cited by:

    1. Joe Peek and James A. Wilcox., 1985. "Taxable and Tax-Exempt Interest Rates: The Role of Personal and Corporate Tax Rates," Research Program in Finance Working Papers 146, University of California at Berkeley.

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