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The traditional view is that interest deductibility encourages firms to use debt financing; however, some argue that the personal tax disadvantage to interest offsets the corporate tax advantage. This paper investigates the degree to which personal taxes affect corporate financing decisions. In crosssectional regressions that control for personal taxes, debt usage is positively correlated with tax rates in each year 1980-1994, with significant coefficients in almost every year. A specification that adjusts tax benefits for the personal tax penalty statistically dominates a specification that does not. The positive (negative) effect of corporate (personal) taxes on debt usage is distinctly identified.

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This paper develops a rational, liquidity-based model of closed-end funds (CEFs) that provides an economic motivation for the existence of this organizational form: They offer a means for investors to buy illiquid securities, without facing the potential costs associated with direct trading and without the externalities imposed by an open-end fund structure. Our theory predicts the patterns observed in CEF initial public offerings (IPOs) and the observed behavior of the CEF discount, which results from a tradeoff between the liquidity benefits of investing in the CEF and the fees charged by the fund’s managers. In particular, the model explains why IPOs occur in waves in certain sectors at a time, why funds are issued at a premium to net asset value (NAV), and why they later usually trade at a discount. We also conduct an empirical investigation, which, overall, provides more support for a liquiditybased model than for an alternative sentiment-based explanation.

are preliminary materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of Governors. References in publications to the Finance and Economics Discussion Series (other than acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers.

We study the marginal tax rate incorporated into short-term tax-exempt municipal rates using a unique new data set from the municipal swap market. By applying an affine term-structure framework, we are able to identify both the marginal tax rate and the credit/liquidity spread in one-week tax-exempt rates. Furthermore, we obtain maximum likelihood estimates of the risk premia associated with these variables. The average marginal tax rate during the sample period is 41.6 percent. We find that the marginal tax rate is significantly positively related to returns in the stock and bond markets. The risk premium associated with the marginal tax rate is negative, consistent with the strong contracyclical nature of aftertax fixed-income cash flows which increase in bad states of the economy as personal income and the effective marginal tax rates applied to those cash flows decline.

Miller (1977) emphasized that optimal corporate financial policy depends on the tax rates facing the firm as well as the tax treatment accorded bond- and stock-holders. In equilibrium, firms will issue claims that are held by the full spectrum of investors, from tax-exempt institutional investors to heavily taxed individuals. However, dealers are tax neutral institutions that can buy corporate securities and, under some circumstances, reissue them as a financial package with different tax characteristics. This activity potentially severs the link between the securities the firm issues and the securities investors hold. In a continuous-time setting with dealers, I show that investors generally will hold derivatives, and possibly stock, in lieu of holding taxable bonds. Moreover, the marginal tax advantage to debt in this setting is the corporate tax rate.

Abstract not found

Using the implied marginal forward tax rate and limited empirical data, we estimate the tax risk premium at roughly 60 basis points, translating into a current market price of tax policy uncertainty of approximately $8 billion per year, a burden imposed on the tax exempt market. This additional cost also represents potential lost tax revenues to the Federal government. The purpose of this paper is to extract the market price of tax policy risk embedded in municipal swap data. The set of implied marginal forward tax rates is estimated based on tax exempt and taxable swap rates. The implied marginal forward tax rate is useful for municipal finance directors who are seeking to establish optimal debt policy as well as researchers seeking to explain the term structure of municipal interest rates. Finally, we explore other uses of the implied marginal forward tax rate for bond market investors, tax exempt issuers, and

This paper examines the effects of losses in U.S. state pension funds on state borrowing costs. Since public‐employee pension obligations are generally senior to state general obligation bonds, increases in unfunded pension liabilities are a serious concern for municipal bond investors. During the 3 months ending December 2008, losses in state pension funds amounted to between 1 % and 6 % of annual gross state product, and between 9 % and 48 % of annual state revenue, depending on the state. Using this cross‐sectional variation, we find that over this period tax‐adjusted municipal bond spreads rose by 10‐20 basis points for each 1 % of annual gross state product lost in pension funds by states in the lower half of the credit quality spectrum. A similar result holds for each 10 % of annual state revenues lost. The effect is approximately constant over the yield curve, suggesting a constant upward shift in annual risk‐neutral default probabilities. These results are robust to controls for credit ratings and other measures of the state’s fiscal strength. They hold within credit rating categories and are strongest among states with the weakest ratings. We conclude that U.S. state borrowing costs will likely increase if unfunded state liabilities continue to grow, making state debt more expensive to finance.