Abstract The classic example of a clientele-based arbitrage strategy involves purchasing tax-exempt bonds with a loan that gives rise to tax-deductible interest in the absence of tax rule restrictions, taxpayers can eliminate theft explicit tax liabilities by investing the debt proceeds in tax-exempt bonds. This paper contributes to the important stream of recent empirical research, which examines the effect of tax policy on investment behavior. The author provide some additional analyses of the arbitrage strategy in the presence of both federal and state income taxes, include some suggestions for future research in this area. The hypothesis of the paper is that banks in deduction states invest more heavily in tax-exempt securities than banks in nondeduction states, depends on the viability of the arbitrage strategy. The author also presents some additional analyses of the issues involved in effecting this tax avoidance strategy and identify some issues that can be addressed in future research. In particular, the effect of debt-to-asset ratios on the marginal tax rates of banks investing in tax-exempt securities should be explored.
Michael Calegari (Wed,) studied this question.