Download This PaperTax Distortions and Bond Issue Pricing
33 Pages Posted: 22 Feb 2016 Last revised: 2 Oct 2017
Date Written: October 1, 2017
Abstract
Original issue premium (OIP) bonds are the norm in the U.S. tax-exempt market, but very rare in the taxable market. A tax subsidy helps explain this disparity. Unlike bonds issued at par or discount, the price of OIP bonds can fall and yet remain above par. Thus, secondary market buyers of tax-exempt OIP bonds receive relatively more tax-exempt coupon and less taxable market discount. Investors' aversion to taxable market discount explains additional, previously undocumented empirical facts. In a calibration exercise, this subsidy's expected cost to the U.S. Treasury is estimated at $1.7 billion per year.
Appendix is available at: https://ssrn.com/abstract=3075670
Keywords: municipal, bonds, tax-exempt, tax distortions, tax arbitrage, coupon, issue price
JEL Classification: G12, G32, G35, G38, H2
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