Taxes on Tax‐Exempt Bonds

Abstract

Implicit tax rates priced in the cross section of municipal bonds are approximately two to three times as high as statutory income tax rates, with implicit tax rates close to 100% using retail trades and above 70% for interdealer trades. These implied tax rates can be identified because a portion of secondary market municipal bond trades involves income taxes. After valuing the tax payments, market discount bonds, which carry income tax liabilities, trade at yields around 25 basis points higher than comparable municipal bonds not subject to any taxes. The high sensitivities of municipal bond prices to tax rates can be traced to individual retail traders dominating dealers and other institutions. Copyright (c) 2010 the American Finance Association.

Municipal Bond Liquidity and Default Risk

“…This is in line with the pre-crisis results in Longstaff (2011) 13 The Internet Appendix is available in the online version of this article on the Journal of Finance website. 14 Ang, Bhansali, and Xing (2010) exploit the tax treatment of market discount bonds to estimate implied income tax rates of 100% for retail trades and 70% for interdealer trades, but their analysis focuses on a subset of secondary market trades. and the short-term estimates in Kueng (2015).…”

“…The academic literature on municipal bonds focuses instead on tax effects and illiquidity as important issues in this market. Most municipal bonds are exempt from federal and state taxes, so the pricing of their cash flows relative to Treasuries has drawn interest (Green (1993), Ang, Bhansali, and Xing (2010), Longstaff (2011)). Trading is done over-the-counter and the tax exemption attracts retail investors as the primary clientele, resulting in high transaction costs due to search frictions and dealer market power (Green, Hollifield, and Schurhoff (2007b), Green, Li, and Schurhoff (2010), Schultz (2012), Li and Schurhoff (2014)).…”

Capital Markets, Infrastructure Investment and Growth in the Asia Pacific Region

“…Tax-exempt bonds are interest bearing redeemable securities issued by government for specific national interest projects or general infrastructure purposes, form part of the government's capital budget for infrastructure spending and are accounted as a liability of the government, Ang, Bhansali and Xing [39]; Marlow [40]. Several countries in the region grant tax exemptions on income receipts from all state bond issues including Malaysia and China, ADB [37].…”

Heterogeneous Taxes and Limited Risk Sharing: Evidence from Municipal Bonds

“…In this paper, we use the U.S. municipal bond market as a laboratory to evaluate the implications of tax-induced ownership patterns for asset returns. Unlike in much previous work (see, for example, Green (1993), Trzcinka (1982), Green, Holli…eld, and Schurho¤ (2007), and Ang, Bhansali, and Xing (2010)), our focus is not on the federal income tax exemption but rather on the state income tax privilege, whereby income from in-state municipal bonds are tax exempt for state residents. This privilege policy, which amounts to states essentially paying local investors to under-diversify, varies signi…cantly across states, resulting in di¤erent levels of in-state ownership of municipal bonds.…”