The Supply Elasticity Of Municipal Debt: Evidence From Bank-Qualified Bonds

This paper provides estimates of the supply elasticity of municipal debt by exploiting a discrete jump in interest rates created by the Tax Reform Act of 1986. To qualify for bank financing of tax-exempt debt, governments can issue no more than 10 million of nominal debt per year. Using bunching methods, I quantify the intensive margin responses to the notch for local governments. The estimates indicate that the average government lowers its borrowing by approximately 5 percent in response to an 8–17 percent increase in interest costs, implying an overall price elasticity of −0. 3 to −0. 6.