Transfer Efficiency and the Trickle-Up Phenomenon in the Market for Small-Issue Private Activity Bonds.

Critics of the tax exemption on private activity bonds (PABs) contend, among other things, that the tax-favored status of these bonds distorts the overall tax-exempt bond market. In so doing, the exemption increases both the inefficiency of the federal revenue transfer to the issuing states or localities and the rate at which the tax advantage associated with the exemption "trickles-up" to bond purchasers in higher tax brackets. This study examines the effect of federal tax policies enacted during the 1960s on the transfer efficiencies and trickle-up yields of samples of small-issue PABs and general obligation bonds issued between 1980 and 1990. The results indicate that the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), the Deficit Reduction Act of 1984 (DRA), and the Tax Reform Act of 1986 (TRA) significantly increased the transfer efficiencies of the bonds while simultaneously reducing the trickle-up yields. Additionally, the results show that these Acts differentially affected the transfer efficiencies and trickle-up yields of the two samples. One implication of these findings, therefore, is that TEFRA, DRA, and TRA restored much of the federal subsidy associated with tax-exempt bonds to the issuing state or local governments.