The Supply Elasticity of Municipal Debt: Evidence from Bank-Qualified Bonds

St.Clair, Travis
National Tax Journal.

This paper provides estimates of the supply elasticity of municipal debt by exploiting a discrete jump in interest rates created by the Tax Reform Act (TRA) of 1986. In order to qualify for bank financing of tax-exempt debt, governments can issue no more than $10 million of nominal debt per year. Using bunching methods, I quantify the intensive margin responses to the notch for counties, municipalities, townships, special districts, and school districts. The estimates indicate that the average marginal bunching government lowers its borrowing by approximately 5 percent in response to a 8-17 percent increase in interest costs, implying an overall price elasticity of -0.3 to -0.6. The behavioral response of special purpose governments is nearly twice as large as that of general purpose governments. The results have implications for the optimal financing of public infrastructure.

Wagner Faculty