TY  - JOUR
AU  - Poterba,James M.
AU  - Verdugo,Arturo Ramirez
TI  - Portfolio Substitution and the Revenue Cost of Exempting State and Local Government Interest Payments from Federal Income Tax 
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 14439
PY  - 2008
Y2  - October 2008
UR  - http://www.nber.org/papers/w14439
L1  - http://www.nber.org/papers/w14439.pdf
N1  - Author contact info:
James M. Poterba
Department of Economics
MIT, E52-350
50 Memorial Drive
Cambridge, MA  02142-1347
Tel: 617/253-6673
Fax: 617/258-7804
E-Mail: poterba@nber.org

Arturo Ramirez Verdugo
Protego Public Finance
Blvd. Manuel Avila Camacho 36, Piso 22
Mexico, D.F.
MEXICO
Tel: 52-55-5249-4336
E-Mail: aramirez@protego.com.mx
M3  - presented at "Economics of Tax Expenditures Conference", March 27-29, 2008
AB  - This paper explores how alternative assumptions about household portfolio behavior affect estimates of the revenue cost of excluding state and local government interest payments from the federal income tax base.  Standard tax expenditure estimates assume that current holders of tax-exempt bonds would replace their holdings of tax-exempt bonds with taxable bonds if the tax exemption were eliminated.  We consider a number of alternative possible portfolio responses.  Because taxable bonds are among the most heavily taxed assets, assuming that investors holding tax-exempt bonds would otherwise hold taxable bonds yields a larger estimate of the revenue cost of tax exemption than many alternative assumptions.  Based on data from the 2004 Survey of Consumer Finances, we estimate that the revenue cost of tax exemption under the "taxable bond substitution hypothesis" is $14.2 billion, compared with $10.1 billion if corporate stock replaces tax-exempt bonds in household portfolios, and $7.9 billion if investors distribute their tax-exempt bond holdings in proportion to the other assets currently in their portfolios.  We also explore the revenue effects of capping the dollar amount of tax-exempt interest per tax return and of limiting tax-exempt interest as a fraction of AGI.
ER  -