Reflections on and Inquiry into Unfamiliar as well as Familar Factors that may Influence the Market for Municipal Bonds

Abstract

This study investigates the impact of various factors on the ex ante real interest rate yield on high grade municipal bonds. The AR/2SLS estimation implies that this ex ante real interest rate is an increasing function of the ex ante real interest rate yield on thirty-year Treasury bonds while being a decreasing function of net capital flows. The yield in question also is found to have been negatively impacted by the Depository Institutions Deregulation and Monetary Control Act. Furthermore, the estimation finds that this interest rate measure is a decreasing function of the maximum marginal federal personal income tax rate. In addition, it is found that, in the presence of an interaction term, the ex ante real interest rate yield on high grade municipals is an increasing function not only of the budget deficit but also the aggregate tax gap. The policy implications of these results include the need to limit the extent of budget deficits and to also limit the extent of income tax evasion in the U.S., lest there will be significant limitations placed on the ability of towns, cities, counties, and states to create new infrastructure in response to changing demographic and economic circumstances and/or maintain existing infrastructure.