The Relationship between Government Financial Condition and Expected Tax Rates Reflected in Municipal Bond Yields
37 Pages Posted: 22 Jun 2007
Date Written: November 1995
Yields on long-term municipal bonds reflect both current and expected future tax rates. This paper derives expected changes in tax rates from yields on short- and long-term municipal bonds and examines the relationship between expected changes in tax rates and the financial condition of the federal government between 1965 and 1994. The main empirical result is that a positive relationship exists between the expected tax rate and federal debt. Inflation also positively affects the expected tax rate, suggesting that investors may expect tight fiscal policies when inflation is high. Qualitative results are similar across specifications, estimators, and sample periods.
Keywords: tax rate, federal debt, municipal bonds, inflation
JEL Classification: E60, H20
Suggested Citation: Suggested Citation