Tax Reform and the Market for Tax-Exempt Debt

44 Pages Posted: 13 Aug 2001 Last revised: 9 Jan 2002

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: March 1989

Abstract

This paper provides clear evidence that the yield spread between long-term taxable and tax-exempt bonds responds to changes in expected individual tax rates, a finding that refutes theories of municipal bond pricing that focus exclusively on commercial banks or other financial intermediaries. The results support the conclusion that in the two decades prior to 1986, the municipal bond market was segmented, with different investor clienteles at short and long maturities. The Tax Reform Act of 1986 is likely to affect this market, however, since it has restricted tax benefits from tax-exempt bond investment by commercial banks. Individual investors are increasingly important suppliers of capital to states and localities, and their tax rates are likely to be the primary determinant of the yield spread between taxable and tax-exempt interest rates in the future.

Suggested Citation

Poterba, James M., Tax Reform and the Market for Tax-Exempt Debt (March 1989). NBER Working Paper No. w2900. Available at SSRN: https://ssrn.com/abstract=278755

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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