Solving the Muni Puzzle: Who Benefits from Tax Exemption of Government Debt?

Konul Amrahova Riegel

Public Finance Review, 2021, vol. 49, issue 1, 71-105

Abstract: I provide a new approach to measuring interest savings associated with issuing tax-exempt municipal bonds (munis) and present empirical evidence offering a solution to the long-standing “muni puzzle.†I show that the tax policy is effective and consistent with theory once I account for idiosyncratic issuer risk and investor preferences. I match tax-exempt munis to near-identical taxable munis issued by the same government at the same time with the same security characteristics to identify the slope of and the trend in implied marginal tax rates. Results of the random coefficients model, which mitigates issuer- and issuance-level unobserved effects, predict the slope of the marginal tax rate to be consistent with asset pricing theory and the tax profile of the typical muni investor. Findings also imply cyclicality over time and heterogeneity in implied marginal tax rates across issuers due to variations in idiosyncratic risk.

Keywords: federal tax expenditure; municipal bonds; muni puzzle; tax exemption policy; implied tax rate (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:sae:pubfin:v:49:y:2021:i:1:p:71-105

DOI: 10.1177/1091142120960372

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