The Influence of Income Tax Rates on the Market for Tax-Exempt Debt

36 Pages Posted: 17 Aug 2009 Last revised: 4 Mar 2010

See all articles by Marc Choate

Marc Choate

Atkinson Graduate School of Management-Willamette University

Michael L. Hand

Willamette University - Atkinson Graduate School of Management

Fred Thompson

Willamette University - Atkinson Graduate School of Management

Date Written: August 16, 2009

Abstract

Based on the indirect arbitrage opportunities afforded citizens by tax-exempt debt issue, this article presents a model establishing equilibrium in the market for tax-exempt debt. The model yields two predictions. Increases in Federal income tax rates increase the spread between taxable and tax-exempt interest rates, but have no effect on the equilibrium quantity demanded and supplied of tax-exempt debt. The latter prediction contrasts with a conventional point of view that increases in tax rates increase demand and supply of tax-exempt debt. The model’s predictions are supported by empirical evidence.

Keywords: tax-exempt debt, indirect arbitrage, state and local government, Wyden-Gregg Tax Act

JEL Classification: H71, H72

Suggested Citation

Choate, George Marc and Hand, Michael L. and Thompson, Fred, The Influence of Income Tax Rates on the Market for Tax-Exempt Debt (August 16, 2009). Available at SSRN: https://ssrn.com/abstract=1455909 or http://dx.doi.org/10.2139/ssrn.1455909

George Marc Choate

Atkinson Graduate School of Management-Willamette University ( email )

900 State Street
Salem, OR 97301
United States

Michael L. Hand

Willamette University - Atkinson Graduate School of Management ( email )

900 State Street
Salem, OR 97301
United States

Fred Thompson (Contact Author)

Willamette University - Atkinson Graduate School of Management ( email )

900 State Street
Salem, OR 97301
United States
503-370-6228 (Phone)
503-370-3011 (Fax)

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