Implicit Taxes: Evidence from Taxable, AMT, and Tax-Exempt State and Local Government Bond Yields

Abstract

Pretax yields of state and local government (SALG) bonds are examined for evidence of implicit taxes. The sample includes fully taxable bonds, alternative minimum tax (AMT) bonds (tax-exempt but a tax preference for alternative minimum tax purposes), and tax-exempt bonds (tax-exempt and not a tax preference for AMT purposes). The average risk-adjusted pretax yield on AMT bonds is higher than that of tax-exempt bonds and lower than that of taxable bonds. Implicit taxes are estimated at 25.23 to 29.68 percent for AMT bonds and 33.87 to 35.27 percent for tax-exempt bonds. Results indicate that asset prices are affected by the AMT system and that marginal investors in AMT bonds assess a positive probability (between 28 and 45 percent) of being subject to the AMT. Estimated implicit tax rates on longer-term tax-exempt bonds are higher when yields are compared to those of taxable SALG bonds rather than taxable U.S. Treasury securities.