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Federal Taxation and the Supply of State Debt

  • Gilbert Metcalf

This paper presents a model of debt finance at the sub-national level from which municipal bond supply equations are derived. Federal tax considerations are shown to be important determinants of the price entering the bond supply equation. Using data on 40 state governments over a seven year period in the 1980s, I show that federal tax rates have an important effect on the supply of municipal bonds - independent of the demand side effect that is usually considered in the literature. Furthermore, the effect persists after controlling for capital expenditures, thereby suggesting that municipal bond proceeds are fungible at the margin. This has implications for the measurement of the tax expenditure associated with tax exempt debt.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3255.

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Date of creation: Feb 1990
Date of revision:
Publication status: published as Journal of Public Economics, Volume 51, pp. 269-285, (1993)
Handle: RePEc:nbr:nberwo:3255
Note: PE
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  1. Bergstrom, Theodore C & Goodman, Robert P, 1973. "Private Demands for Public Goods," American Economic Review, American Economic Association, vol. 63(3), pages 280-96, June.
  2. Borcherding, Thomas E & Deacon, Robert T, 1972. "The Demand for the Services of Non-Federal Governments," American Economic Review, American Economic Association, vol. 62(5), pages 891-901, December.
  3. Engle, Robert F., 1984. "Wald, likelihood ratio, and Lagrange multiplier tests in econometrics," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 2, chapter 13, pages 775-826 Elsevier.
  4. Martin Feldstein & Gilbert Metcalf, 1986. "The Effect of Federal Tax Deductibility on State and Local Taxes and Spending," NBER Working Papers 1791, National Bureau of Economic Research, Inc.
  5. Metcalfe, G.E., 1988. "Federal Tax Policy And Municipal Financial Behavior," Papers 29, Princeton, Woodrow Wilson School - Discussion Paper.
  6. Stewart C. Myers, 1984. "Capital Structure Puzzle," NBER Working Papers 1393, National Bureau of Economic Research, Inc.
  7. Poterba, James M., 1989. "Tax reform and the market for tax-exempt debt," Regional Science and Urban Economics, Elsevier, vol. 19(3), pages 537-562, August.
  8. James M. Poterba, 1986. "Explaining the Yield Spread between Taxable and Tax-exempt Bonds: The Role of Expected Tax Policy," NBER Chapters, in: Studies in State and Local Public Finance, pages 5-52 National Bureau of Economic Research, Inc.
  9. Epple, Dennis & Spatt, Chester, 1986. "State restrictions on local debt : Their role in preventing default," Journal of Public Economics, Elsevier, vol. 29(2), pages 199-221, March.
  10. Alan J. Auerbach, 1983. "Real Determinants of Corporate Leverage," NBER Working Papers 1151, National Bureau of Economic Research, Inc.
  11. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
  12. Sally A. Asefa & Roy D. Adams & Dennis R. Starleaf, 1981. "Municipal Borrowing: Some Empirical Results," Public Finance Review, , vol. 9(3), pages 271-280, July.
  13. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  14. Roger H. Gordon & Joel Slemrod, 1985. "An Empirical Examination of Municipal Financial Policy," NBER Working Papers 1599, National Bureau of Economic Research, Inc.
  15. Gilbert E. Metcalf, 1989. "Arbitrage and the Savings Behavior of State Governments," NBER Working Papers 3017, National Bureau of Economic Research, Inc.
  16. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  17. Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-92, July.
  18. Fortune, Peter, 1988. "Municipal Bond Yields: Whose Tax Rates Matter?," National Tax Journal, National Tax Association, vol. 41(2), pages 219-33, June.
  19. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  20. Inman, Robert P., 1987. "Markets, governments, and the "new" political economy," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 2, chapter 12, pages 647-777 Elsevier.
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