Abstract
While the research linking interest rates to government deficits is extensive, the impact of other tax-related variables is uncommon. This study seeks to add to the literature on credit markets by exploring the impact of not only the budget deficit but also average effective personal income tax rates and personal income tax evasion as explanatory variables. To the best of our knowledge this study is the first study to recognize the joint importance of all of these fiscal variables. We utilize data covering the post-Bretton Woods period from 1971 through 2016 to analyze the impact of the three variables in order to shed light on the spread between the real interest rate yields on Moody’s Aaa-rated corporate bonds and high quality municipal bonds. Estimations reveal that the higher the average effective federal personal income tax rate, the greater the differential between the yields on corporate bonds and tax-free Municipals. Furthermore, it is found that the higher the adjusted gross income gap, the greater the real yield spread between Moody’s Aaa-rated corporate bonds and high quality municipal bonds. Finally, the greater the primary budget deficit, the greater the spread as well.
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Notes
This variable reflects personal income tax evasion and the so-called informal economy in the form of unreported taxable income to the IRS.
This is because, under these circumstances, the tax-exempt status of the municipal bonds makes their after-tax ex post real interest rate yield, EPRTF, more attractive, whereas the after-tax ex post real interest rate yield on the Aaa-rated corporate bonds EPRAAA, is diminished and therefore made less attractive, ceteris paribus.
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Cebula, R.J., Capener, D., Foley, M. et al. Spread between the Moody’s Aaa-Rated Corporate Bond Yield and the Yield on Municipals: Co-integration Analysis. Atl Econ J 48, 175–184 (2020). https://doi.org/10.1007/s11293-020-09668-0
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DOI: https://doi.org/10.1007/s11293-020-09668-0
Keywords
- Interest rate yield on Moody’s Aaa-rated bonds
- Yield on tax-fee municipals
- Yield spread
- Average effective personal income tax rate
- AGI gap
- Primary deficit
- Informal economy