Expected Future Tax Policy and Tax-Exempt Bond Yields

67 Pages Posted: 26 Dec 2001 Last revised: 9 Jul 2010

See all articles by James M. Poterba

James M. Poterba

National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Department of Economics

Date Written: September 1984


This paper tests several competing models of municipal bond market equilibrium. It analyzes the influence of changes in both personal and corporate tax reforms on the yield spread between taxable and tax-exempt interest rates. The findings suggest that changes in personal income tax rates have pronounced effects on long-term municipal interest rates, but small effects on short-maturity yields. Corporate tax reforms, however, affect both long- and short-term yields. These results are inconsistent with the view that the relative yields on taxable and tax-exempt bonds are set by banks and insurance companies which are taxed at the corporate rate. They support the more traditional view that banks are the primary holders of short-term muncipal securities, while households are the principal investors in the long-term municipal market. This view suggests that proposals to reform municipal financing policies by increasing the use of short-term borrowing, or issuing long-term floating-rate debt, could reduce the real cost of municipal borrowing.

Suggested Citation

Poterba, James M., Expected Future Tax Policy and Tax-Exempt Bond Yields (September 1984). NBER Working Paper No. w1469. Available at SSRN: https://ssrn.com/abstract=278752

James M. Poterba (Contact Author)

National Bureau of Economic Research (NBER) ( email )

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Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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