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

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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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This article analyzes the determinants of state debt financing-including the composition of government spending and the desire to make intergenerational transfers, as well as a variety of economic, political, and institutional factors. The authors find that a greater proportion of younger voters is correlated with increased debt at the state level, but a greater proportion of elderly voters is correlated with decreased debt, probably because of the composition of state government spending. Moreover, the authors find that political variables are largely irrelevant to the accumulation of debt at the state level and that some types of institutional restraints are effective in limiting the size of state debt.
Although the goal of government is to maintain or improve citizens' well-being, governmental commitments are subject to fiscal constraints. Given constraints on resources, governments need to "live within their means" (GASB 1987, para. 59). Concepts Statement No. 1 (GASB 1987, para. 61) discusses the notion of interperiod equity (IPE), i.e., whether "current year revenues are sufficient to pay for the services provided that year." From a financial reporting perspective, the Board believes that the appropriate concept is that of "yearly balance" and that services rendered during the current year should be paid for by revenues raised during that year. The public economics literature (e.g., Aguilar et al. 1991; Mattoon and Testa 1991) suggests that the time horizon of public officials is longer than a single fiscal year and that taxes and spending are smoothed over a multi-period time frame. This literature indicates it would be unrealistic for governmental revenues and expenditures to be balanced each and every year. Despite the potentially wide disparity between a one-year and a multi-year budgeting perspective for governments, we are not aware of any extant research on the issue. This paper provides an empirical analysis of three interperiod equity-related performance measures for 40 large cities over a 35-year period in order to examine which budgeting perspective seems, in fact, to exist. We use a partial adjustment model under the hypothesis that cities' performance measures tend to move toward governmental norms in a manner similar to Lev's (1969) findings for businesses. Our empirical results (1) are consistent with a multi-year budgeting horizon, (2) provide benchmarks for each of the three performance measures against which users of financial statements can compare governmental results, and (3) suggest that the speed of adjustment toward governmental norms (which varies across cities) could be useful to users of financial statements as a measure of a government's capacity to adapt and adjust to changing economic circumstances.
This article reviews the theory of individual preferences between tax and bond finance of municipal expenditures and tests the hypotheres that cities' borrowing will vary in relation to the cities' capital expenditures, median income, bond rating, and the population level, growth, mobility, and age composition. Differences in bond ratings, population, and population growth did not prove significant, but median income, capital expenditures, and population mobility were found to have statistically significant effects on the percentage of city expenditures financed by borrowing.
The linkage between federal policy and municipal investment decisions is empirically estimated. The findings of this article indicate that federal policies should be designed with recognition of the potential effects on local investment decisions. Deductibility of state and local taxes is found to have a strong effect on demand for investment. Intergovernmental aid appears to have a small positive influence on investment demand. Investment demand is estimated to have grown after passage of the Tax Reform Act of 1986 (TRA86). Because TRA86 eliminated sales tax deductibility, this suggests that sales taxes are not used at the margin to finance investments. Factors not related to federal tax policy, such as mandates, must explain the subsequent investment growth. Evidence is found that federal policies can increase investment by influencing municipal willingness to issue debt, as measured by the percentage of resources raised through debt. However, the effect disappears when the debt share is simultaneously estimated with investment demand
I present new evidence on the direct costs of bankruptcy and violation of priority of claims. In a sample of 37 New York and American Stock Exchange firms that filed for bankruptcy between November 1979 and December 1986, direct costs average 3.1% of the book value of debt plus the market value of equity, and priority of claims is violated in 29 cases. The breakdown in priority of claims occur primarily among the unsecured creditors and between the unsecured creditors and equity holders. Secured creditors' contracts are generally upheld.
A conceptual framework and multiequation model of the local public sector and property market is developed in order to test the implications of the Ricardo-Barro debt equivalence hypothesis. Substituting one debt dollar for one dollar of current real property taxes to finance a given level of expenditure implies a one dollar reduction in aggregate property values if taxpayers discount future taxes arising from debt issue. Data referring to forty-eight New York State cities in 1980 are used to calibrate the model. Using both ordinary least squares and two stage least squares, no evidence to support debt equivalence is detected.
Reprint. Originally publ.: Chapel Hill : University of North Carolina Press, 1964. Incl. bibl., index.
Typescript. Thesis (Ph. D.)--New York University, Robert F. Wagner Graduate School of Public Service, 2001. Includes bibliographical references (leaves 115-125).
The debt illusion hypothesis holds that taxpayers may underestimate the present discounted value of future tax liabilities under debt finance. The empirical question arises as to whether debt illusion at the local government level can affect housing values. This proposition is evaluated by investigating whether local fiscal variables are fully capitalised into housing values by means of a pooled time-series, cross-sectional analysis of 27 metropolitan municipalities in Sydney, Australia, for the period 1989 to 1991. The results indicate that municipal debt is under-capitalised into housing values, and accordingly suggests that local government expenditure may be systematically biased upwards.
This paper examines the effect of federal deductibility of state and local taxes on the fiscal behavior of state and local governments. The primary finding is that deductibil ity affects the way that state and local governments finance their sp ending as well as the overall level of spending. More specifically, i n states in which federal deductibility implies a relatively low cost of using deductible personal taxes (including income, sales, and pro perty taxes), there is greater reliance on those taxes and less relia nce on business taxes and other revenue sources. The effect of deduct ibility on the state and local financial mix implies that deductibili ty has a much lower cost to the federal government than has previousl y been assumed. Copyright 1987 by University of Chicago Press.
A public debt theory is constructed in which the Ricardian invariance theorem is valid as a first-order proposition but where the dependence excess burden on the timing of taxation implies an optimal time path of debt issue. A central proposition is that deficits are varied in order to maintain expected constancy in tax rates. This behavior implies a positive effect on debt issue of temporary increases in government spending (as in wartime), a countercyclical response of debt to temporary income movements, and a one-to-one effect of expected inflation on nominal debt growth. Debt issue would be invariant with the outstanding debt-income ratio and, except for a mirror effect, with the level of government spending. Hypotheses are tested on U.S. data since World War I. Results are basically in accord with the theory. It also turns out that a small set of explanatory variables can account for the principal movements in interest-bearing federal debt since the 1920s.
This paper examines the effect of federal deductibility of state and local taxes on the fiscal behavior of state and local governments. The primary finding is that deductibility affects the way that state-local governments finance their spending as well as the overall level of spending. More specifically, in states where federal deductibility implies a relatively low cost of using deductible personal taxes (including income,sales and property taxes), there is greater reliance on those taxes and less reliance on business taxes and other revenue sources.The effect of deductibility on the state-local financial mix implies that deductibility has a much lower cost to the federal government than has previously been assumed. Indeed, if deductibility causes a large enough shift of financing from business taxes to personal taxes, deductibility may actually raise federal tax receipts. The analysis also implies that deductibility is likely to be a more cost-effective way than direct grants for raising the general level of state-local government spending. The present study uses the individual tax return data in the NBER TAXSIM model to calculate federal tax prices for itemizers and other taxpayers in each state. The econometric analysis recognizes that the federal tax price is endogenous (because it reflects the state-local spending decisions) and therefore uses a consistent instrumental variable procedure. This use of instrumental variable estimation exacerbates the difficulty of making precise estimates from the data. The relatively large standard errors indicate the need for caution in interpreting the point estimates.
In the United States, local government expenditures are heavily subsidized through a variety of sources. This paper explores theoretically and then simulates empirically the effects of eliminating either of two federal subsidies encouraging local government expenditures: (1) income tax deductibility of local tax payments, and (2) the tax exempt status of interest on municipal bonds.We find that eliminating the deductibility of local taxes raises the utility of all income groups, and of home owners as well as of renters.Making interest on municipal bonds taxable, however, substantially hurts the very rich, who lose a tax shelter, and may hurt the very poor, who pay more for municipal services. While most people gain, the net gain is very small.
University of Rochester. The author wishes to thank M. Gruber, R. Hamada, F. Jen, M. Jensen, E. H. Kim, E. Kitch, M. Scholes, J. Siegel, C. Smith, B. Stone, H. Stoll, and J. Williams for their comments on previous drafts. I am indebted to N. Gonedes and especially M. Miller for their encouragement and for their criticisms of previous versions of the paper.
The burden of the public debt: comment
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