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How Prevalent is Tax Arbitrage? Evidence from the Market for Municipal Bonds

  • Merle Erickson
  • Austan Goolsbee
  • Edward Maydew

Although tax arbitrage is central to the literatures on tax capitalization, implicit taxes, and even capital structure, there is little empirical evidence of the extent to which firms actually engage in tax arbitrage. This paper provides some evidence on the topic by focusing on a simple and observable corporate arbitrage strategy in the market for municipal bonds. It poses a puzzle for the literature, however, in that we find little evidence of municipal bond tax arbitrage by non-financial corporations. The overwhelming majority of firms are not engaging in the arbitrage at all and even among those engaged in arbitrage, many firms do less than a safe-harbor amount allowed by the tax authorities. Such a pattern is consistent with the presence of both fixed and marginal (i.e., that depend on size of the position) costs of arbitrage, though we cannot observe what those costs are.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9105.

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Date of creation: Aug 2002
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Handle: RePEc:nbr:nberwo:9105
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  1. Buser, Stephen A. & Hess, Patrick J., 1986. "Empirical determinants of the relative yields on taxable and tax-exempt securities," Journal of Financial Economics, Elsevier, vol. 17(2), pages 335-355, December.
  2. Trzcinka, Charles A, 1982. " The Pricing of Tax-Exempt Bonds and the Miller Hypothesis," Journal of Finance, American Finance Association, vol. 37(4), pages 907-23, September.
  3. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
  4. Joel Slemrod & Timothy Greimel, 1998. "Did Steve Forbes Scare the Municipal Bond Market?," NBER Working Papers 6583, National Bureau of Economic Research, Inc.
  5. 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.
  6. Graham, John R., 1996. "Proxies for the corporate marginal tax rate," Journal of Financial Economics, Elsevier, vol. 42(2), pages 187-221, October.
  7. Shackelford, Douglas A., 1991. "The market for tax benefits : Evidence from leveraged ESOPs," Journal of Accounting and Economics, Elsevier, vol. 14(2), pages 117-145, June.
  8. Kaplan, Steven, 1989. " Management Buyouts: Evidence on Taxes as a," Journal of Finance, American Finance Association, vol. 44(3), pages 611-32, July.
  9. Peter Fortune, 1996. "Do municipal bond yields forecast tax policy?," New England Economic Review, Federal Reserve Bank of Boston, issue Sep, pages 29-48.
  10. Poterba, J.M., 1989. "Tax Reform And The Market For Tax-Exempt Debt," Working papers 514, Massachusetts Institute of Technology (MIT), Department of Economics.
  11. Gentry, William M., 2002. "Debt, investment and endowment accumulation: the case of not-for-profit hospitals," Journal of Health Economics, Elsevier, vol. 21(5), pages 845-872, September.
  12. Kochin, Levis A & Parks, Richard W, 1988. " Was the Tax-Exempt Bond Market Inefficient or Were Future Expected Tax Rates Negative?," Journal of Finance, American Finance Association, vol. 43(4), pages 913-31, September.
  13. Scholes, Myron S & Wilson, G Peter & Wolfson, Mark A, 1990. "Tax Planning, Regulatory Capital Planning, and Financial Reporting Strategy for Commercial Banks," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 625-50.
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