AN ANALYSIS OF IMPLIED TAX RATES ON LONG-TERM TAXABLE AND TAX-EXEMPT BONDS

We examine the impact differences in interest rate volatility, the tax ation of capital gains and losses, capability, the Tax Reform Act of 1 986, corporate and personal tax rates, and the value of the tax-timing option on the equilibrium yield relationship between long-term tax-ex empt and taxable bonds. Tax consequences of each of these factors for investors potentially influence the implied tax rate associated with t au-exempt and taxable bonds. Using monthly data from 1957 through 1988 we estimate time series regression equations that relate the ratio of par yields on 20-year and 30-year tax-exempt and Treasury securities to these tax and volatility factors. The empirical results indicate th at (1) increased volatility ol municipal yields had a strong, positive impact on the equilibrium yield ratio, (2) changes in marginal person al income tax rates negatively affected the yield ratio; and (3) chang es in the Treasury yield curve slope negatively influenced the yield r atio. None of these factors affected the yield ratio differently after 1986. (C) 1997 Elsevier Science Inc.