State Income Tax Changes and the Demand for Municipal Bond Funds

47 Pages Posted: 17 Sep 2020 Last revised: 18 Mar 2021

See all articles by Jon A. Fulkerson

Jon A. Fulkerson

University of Dayton

Nancy Haskell

University of Dayton - School of Business Administration - Department of Economics and Finance

Date Written: February 23, 2021

Abstract

We consider how state income tax changes affect the demand for municipal bonds by in-state investors. A tax increase (decrease) makes investing in municipal bonds more (less) desirable, and theory predicts a change in demand by investors until the yields on municipal bonds reach a new equilibrium. Using a sample of state-specific municipal bond funds, we find states with tax decreases have net outflows in the following year of approximately 2% per percentage point drop in tax rates, while tax increases lead to inflows around 1.58%. We find that the response to tax changes is not the immediate reallocation predicted in perfect markets with no frictions.

Keywords: municipal bonds; mutual funds; bond funds; state income tax

JEL Classification: G11; H24

Suggested Citation

Fulkerson, Jon A. and Haskell, Nancy, State Income Tax Changes and the Demand for Municipal Bond Funds (February 23, 2021). Available at SSRN: https://ssrn.com/abstract=3684063 or http://dx.doi.org/10.2139/ssrn.3684063

Jon A. Fulkerson (Contact Author)

University of Dayton ( email )

300 College Park
Dayton, OH 45469
United States

Nancy Haskell

University of Dayton - School of Business Administration - Department of Economics and Finance ( email )

300 College Park
Dayton, OH 45469
United States

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