Arbitrage and the Savings Behavior of State Governments

24 Pages Posted: 28 Dec 2006

See all articles by Gilbert E. Metcalf

Gilbert E. Metcalf

Tufts University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: June 1989

Abstract

The federal tax code creates strong incentives for tax arbitrage activity on the part of state governments. This arbitrage activity is illegal and previous research has typically assumed that the constraint against arbitrage activity is binding. This paper explicitly tests this proposition by considering whether financial asset holdings increase as the yield spread between taxable and tax exempt securities rises. Using a data set on 40 state governments over a 7 year period, I find that there is a significant response to changes in the yield spread. One implication of these results is that the Tax Reform Act of 1986 which made even greater efforts to curb arbitrage activity is likely to be ineffective.

Suggested Citation

Metcalf, Gilbert E., Arbitrage and the Savings Behavior of State Governments (June 1989). NBER Working Paper No. w3017. Available at SSRN: https://ssrn.com/abstract=463462

Gilbert E. Metcalf (Contact Author)

Tufts University - Department of Economics ( email )

Medford, MA 02155
United States
617-627-3685 (Phone)
617-627-3917 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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