The Municipal Bond Federal Tax Exemption and National Credit Conditions

Abstract

THE MUNICIPAL BOND FEDERAL TAX EXEMPTION AND NATIONAL CREDIT CONDITIONS

Alexander J. Karjeker, B.S., B.A.

Thesis Advisor: Jeffrey Larrimore, Ph.D.

ABSTRACT

This paper builds on existing literature in estimating the determinants of municipal bond interest rates (yields). Much of that body of work has taken into account various factors, including most prominently, federal income tax rates and the municipal bond interest exemption. After the most recent financial crisis and policy response, new market data has become available to measure the riskiness of these bonds during a major recession and liquidity crunch. Further, current policy discussions now include the removal of the exemption. This research will examine what effect such policy would have on municipal bond yields and additionally, whether that effect would be the same or different in a post-financial crisis environment. The results indicate that a change in this policy would increase yields in a statistically significant way. However, changing policy in a post-financial crisis environment would not move yields in a perceivable way, though the effect is statistically significant. These are important conclusions for policy makers to consider when evaluating budgetary priorities.