Voter-induced Municipal Credit Risk

83 Pages Posted: 19 Jun 2023 Last revised: 5 Nov 2024

See all articles by Brent W. Ambrose

Brent W. Ambrose

Pennsylvania State University - Department of Insurance & Real Estate

Matthew Gustafson

Pennsylvania State University - Smeal College of Business

Maxence Valentin

ETH Zürich - Department of Management, Technology and Economics

Zihan Ye

University of Tennessee

Date Written: May 13, 2024

Abstract

Policy shocks that increase the costs of public goods should simultaneously reduce voter support for them. We study the extent to which this creates a corresponding voter-induced municipal credit risk. We exploit changes to state and local tax (SALT) deductions from the Tax Cut and Jobs Act as a policy shock to the costs of local public goods. In a difference-in-differences framework with repeated bond trades, we find that jurisdictions with a higher share of residents who ceased deducting SALT (and therefore face a higher marginal cost of local public goods) experienced a significant increase in municipal bond yields, with an average treatment effect of 8.3 basis points, or 3.0% of the unconditional average yield spread. This effect is concentrated in areas where residents have a direct impact on municipal financing decisions via ballot initiatives. This study thus demonstrates the importance of voters in the pricing of public debt and extends the discussion of political and policy uncertainty, and therefore coordination and agency problems, to the municipal context.

Keywords: Municipal Bond Risk, Voting, Local Public Finance, Tax Cuts and Jobs Act, Principal-agent Coordination

JEL Classification: G1, G5, H2, H3, H7

Suggested Citation

Ambrose, Brent W. and Gustafson, Matthew and Valentin, Maxence and Ye, Zihan, Voter-induced Municipal Credit Risk (May 13, 2024). Available at SSRN: https://ssrn.com/abstract=4474257 or http://dx.doi.org/10.2139/ssrn.4474257

Brent W. Ambrose

Pennsylvania State University - Department of Insurance & Real Estate ( email )

Smeal College of Business,
Penn State University
University Park, PA US-0-PA 16802
United States
8148670066 (Phone)

HOME PAGE: http://https://sites.psu.edu/brentwambrose/

Matthew Gustafson

Pennsylvania State University - Smeal College of Business ( email )

East Park Avenue
University Park, PA 16802
United States

Maxence Valentin (Contact Author)

ETH Zürich - Department of Management, Technology and Economics ( email )

Rämistrasse 101
ZUE F7
Zürich, 8092
Switzerland

Zihan Ye

University of Tennessee ( email )

Haslam Business Building
453, 1000 Volunteer Blvd,
Knoxville, TN TN 37916
United States

HOME PAGE: http://https://sites.google.com/view/zihanye/home

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