Why are tax-exempt bonds issued at a premium?*

I derive the optimal timing strategy for an investor taking tax gains and losses on tax-exempt bonds (up to a 7% gain over buy-and-hold). I then derive the issuer’s optimal coupon rate, which maximizes the tax benefit for a tax-timing investor (up to a 3.5% gain over issuing at par, potentially more than the cost of issuance itself). All these gains are transfers from the U.S. Treasury to local issuers or investors. The optimal issuance policy is consistent with three unexplained stylized facts: the frequent issuance of premium bonds; “sticky” coupons that don’t fall when yields fall; and higher issue prices for longermaturity noncallable bonds. *PRELIMINARY—PLEASEDONOTCITEWITHOUTTHEAUTHOR’S PERMISSION. COMMENTS AREWELCOME.