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Taxes on Tax-Exempt Bonds

  • Andrew Ang
  • Vineer Bhansali
  • Yuhang Xing

Implicit tax rates priced in the cross section of municipal bonds are approximately two to three times as high as statutory income tax rates, with implicit tax rates close to 100% using retail trades and above 70% for interdealer trades. These implied tax rates can be identified on the cross section of municipal bonds because a portion of secondary market municipal bond trades involve income taxes. After valuing the tax payments, market discount bonds, which carry income tax liabilities, trade at yields around 25 basis points higher than comparable municipal bonds not subject to any taxes. The high sensitivities of municipal bond prices to tax rates can be traced to individual retail traders dominating dealers and other institutions.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14496.

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Date of creation: Nov 2008
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Publication status: published as Andrew Ang & Vineer Bhansali & Yuhang Xing, 2010. "Taxes on Tax-Exempt Bonds," Journal of Finance, American Finance Association, vol. 65(2), pages 565-601, 04.
Handle: RePEc:nbr:nberwo:14496
Note: AP PE
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