Tax Advantages and Imperfect Competition in Auctions for Municipal Bonds∗

We show that the effect of tax advantages of municipal bonds on the market microstructure of municipal bond auctions is a crucial determinant of state and local governments’ borrowing costs. Reduced-form estimates show that increasing the tax advantage by 3-pp. lowers mean borrowing costs by 9-10%, consistent with a greater-than-unity passthrough elasticity. Non-parametric evidence shows that strategic participation and bidding in imperfectly-competitive auctions generates this greater-than-unity passthrough. Using a structural auction model to evaluate the efficiency of Obama and Trump administration proposals, we find that the reduction in municipal borrowing costs is 2.8-times the revenue cost of the tax advantage. JEL Codes: D44, H71, L13 ∗We are very grateful for comments from Manuel Adelino, Hunt Allcott, Pat Bayer, Vivek Bhattacharya, Josh Gottlieb, Ali Hortaçsu, Lorenz Kueng, Tong Li, Justin Marion, Jon Meer, Matt Panhans, Jim Poterba, Clemens Sialm, and Owen Zidar. Suárez Serrato is grateful for funding from the Kauffman Foundation. All errors remain our own.