Home      Login

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.

Keywords: Capital structure; indirect arbitrage gains; aggregate demand and supply equilibrium;

Affiliations:  1: Atkinson Graduate School of Management, Willamette University; 2: Atkinson Graduate School of Management, Willamette University; 3: Atkinson Graduate School of Management, Willamette University.