Municipal Debt: What Does It Buy and Who Benefits?

Abstract

This paper examines the incidence of the federal income tax exemption of interest on state and local bonds, applying a fixed-savings, simplified general equilibrium approach to estimate incidence effects on both the sources and uses of income. In contrast to traditional empirical work that allocates the benefit of tax exemption only to current holders of tax-exempt bonds based on current interest rates, we incorporate the fact that the existence of tax exemption causes the taxable interest rate to rise and the tax-exempt rate to fall. As a consequence, on the sources side, tax exemption can increase after-tax income for holders of both taxable and taxexempt bonds. On the uses side, consumers of both private and public goods are affected by the higher cost of funds to private and federal government borrowers, the lower cost of funds to state and local borrowers, and the lower cost of funds to private-sector entities with access to the proceeds of tax-exempt borrowing. Overall, higher income individuals remain the primary beneficiaries of tax exemption on the sources side with this new approach, but less so than under the traditional approach. On the uses side, households who consume a relatively large share of state and local public services, such as those with several school-age children, receive significant net benefits.

Taxes and tax‐exempt bonds: A literature review

“…(2014) and Galper et al. (2014) reach a similar conclusion using an updated model that considers the impact of the tax exemption on interest rates, private consumption, and the composition of investor portfolios. They assign the benefits of municipal projects financed through debt, as well as the associated borrowing cost saving across the full income distribution.…”

Tax Advantages and Imperfect Competition in Auctions for Municipal Bonds

“…We focus on the efficacy of the taxexemption directly, instead of analyzing other mechanisms that may also lower municipal borrowing costs. Our paper is also related to papers that study the implications of removing the tax subsidy for municipal debt for individual portfolio substitution (Feenberg and Poterba, 1991;Poterba and Verdugo, 2011), and for changes in municipal spending (Gordon and Slemrod, 1983;Galper et al, 2014).…”

Public Borrowing for Private Organizations: Costs and Structure of Tax‐Exempt Debt Through Conduit Issuers

“…Although conduit issuers often borrow for other governments, this paper focuses on the borrowing activity of private nonprofit and for‐profit organizations through these public entities . As of 2013, private nonprofit and for‐profit borrowers were responsible for 20.3 percent, or $746 billion, of all outstanding tax‐exempt debt (Galper et al ). The issuance of tax‐exempt debt for private organizations through conduits has a contentious history (Hildreth and Zorn ), culminating in limits to private activity bonds imposed by the Tax Reform Act of 1986 (TRA86) (US GAO ).…”

“…The issuance of tax‐exempt debt for private organizations through conduits has a contentious history (Hildreth and Zorn ), culminating in limits to private activity bonds imposed by the Tax Reform Act of 1986 (TRA86) (US GAO ). In 2015, the tax‐exemption on interest payments from bonds issued on behalf of private entities cost the federal government an estimated $10.5 billion in foregone income tax collections (Galper et al ).…”