Aging and Public Financing Costs: Evidence from U.S. Municipal Bond Markets

Abstract

We examine the effect of population aging on state municipal bond issuance cost. A one standard deviation increase in the fraction of population that is 65 or older leads to a 23-24 basis point increase in bond issue yield spread. Reduced personal income tax revenue, increased pension obligations, and increased retiree healthcare liabilities together explain approximately 50% of the effect. We exploit historical trends in birth rates to construct an instrumental variable. The findings suggest that demographic changes impact state governments’ fiscal conditions through affecting their cost of accessing the financial market.

Keywords: Municipal Finance, Public Finance, Aging, Public Pensions, Demographics

JEL Classification: G12, G23, H74, H75, J11, J14