The Role of Federal Taxation in the Supply of Municipal Bonds: Evidence From Municipal Governments

Gilbert E. Metcalf

NBER Working Paper No. 3891
Issued in November 1991
NBER Program(s):Public Economics Program

This paper considers ways in which federal tax policy affects municipal asset and debt holdings. The tax treatment of municipal bonds and income creates an arbitrage opportunity for communities to issue tax exempt debt and invest in financial assets. I present evidence that suggests the rules in effect prior to 1986 to prevent this activity were not effective. I then develop and estimate a model of municipal bond supply. I find a semi-elasticity of 1.23 of long term debt with respect to the spread between the after tax rate of return and the municipal borrowing rate.

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Document Object Identifier (DOI): 10.3386/w3891

Published: National Tax Journal, Volume XLIV, No. 4, Part 1: December, 1991. Cambridge: The MIT Press. Available through NBER.

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