The Influence of Income Tax Rates on the Market for Tax-Exempt Debt

G. Marc Choate, Michael L. Hand and Fred Thompson

Municipal Finance Journal, 2010, vol. 31, issue 1, 41 - 60

Abstract: Based on the indirect arbitrage opportunities afforded citizens by tax-exempt debt issue, this article presents a model establishing equilibrium in the market for tax-exempt debt. The model yields two predictions: (1) Increases in federal income tax rates increase the spread between taxable and tax-exempt interest rates; (2) these increases have no effect on the equilibrium quantity demanded and supplied of tax-exempt debt. The latter prediction contrasts with a conventional point of view that increases in tax rates increase demand and supply of tax-exempt debt. The model’s predictions are supported by empirical evidence.

Date: 2010
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Persistent link: https://EconPapers.repec.org/RePEc:ucp:munifj:doi:10.1086/mfj31010041

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