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Do Tax-Exempt Bonds Really Subsidize Municipal Capital?

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  • Roger H. Gordon
  • Gilbert E. Metcalf

Abstract

We argue that the tax-exempt status of municipal bonds provides little or no subsidy to capital investment by communities. Instead, the tax exemption simply provides arbitrage opportunities to high and low tax bracket individuals while leaving individuals in intermediate tax brackets essentially unaffected. We also argue that the revenue cost of the tax exemption is much less than traditionally thought due to the portfolio rebalancing that would occur if the tax exemption were eliminated. Finally, we note that the only way to prevent all municipal arbitrage possibilities would be to pass through municipal interest income and payments to residents for tax purposes.

Suggested Citation

  • Roger H. Gordon & Gilbert E. Metcalf, 1991. "Do Tax-Exempt Bonds Really Subsidize Municipal Capital?," NBER Working Papers 3835, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:3835
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    Cited by:

    1. James M. Poterba & Arturo Ramirez Verdugo, 2008. "Portfolio Substitution and the Revenue Cost of Exempting State and Local Government Interest Payments from Federal Income Tax," NBER Working Papers 14439, National Bureau of Economic Research, Inc.
    2. Merle Erickson & Austan Goolsbee & Edward Maydew, 2002. "How Prevalent is Tax Arbitrage? Evidence from the Market for Municipal Bonds," NBER Working Papers 9105, National Bureau of Economic Research, Inc.
    3. Peter Fortune, 1995. "Debt capacity, tax exemption, and the municipal cost of capital: a reassessment of the new view," Working Papers 95-8, Federal Reserve Bank of Boston.
    4. Edward L. Glaeser, 2012. "Urban Public Finance," NBER Working Papers 18244, National Bureau of Economic Research, Inc.
    5. Peter Fortune, 1996. "Tax-exempt bonds really do subsidize municipal capital!," Working Papers 96-9, Federal Reserve Bank of Boston.
    6. Hulten, Charles R. & Schwab, Robert M., 1997. "A fiscal federalism approach to infrastructure policy," Regional Science and Urban Economics, Elsevier, vol. 27(2), pages 139-159, April.

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