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Property Tax Exemptions and Tax-Exempt Bonds: Do Federal Income Tax Exemptions Influence Municipal Capital Finance?

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Abstract

Abstract The federal incometax deduction for property taxes and tax-exempt municipal bonds are a substantial subsidy to local governments. Atax deductibilityhypothesis is postulated to explain whycommunitie,s might have differing preferences for the way their local government chooses to finance long termassets. Em pirical findings are consistent with the tax deductibility hypothesis of municipal finance in that high incomecommunities,in New Jersey favor property taxes, while low incomecommunities favor tax-exempt debt. The variables employed to gauge whether the residents were likely to itemize deductions on their federal incometax return also have a statistically significant relationship to a municipality’suse of propertytax financing. The observed impact of the tax deductibility variables on debt financing is different than postulated, suggesting thatf actors in addition to the tax deductibilityhypothesis also motivate the use of debt financing.

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