ABSTRACT
Municipal investment is subsidized by the tax-exempt status of municipal bonds only if increasing capital investment by an extra dollar enables a community to borrow more, and thereby gain more from its right to borrow at this low rate. If taxes were used to finance the project, residents would therefore find their income reduced in each future period by r(1 −1) times the cost of the capital project. But if the project had instead been financed entirely with debt, then future taxes would be r times the cost of the capital project. Tax revenue increases only to the degree to which the typical purchaser of a municipal bond is in a higher tax bracket than the typical resident of a community undertaking a capital investment project. Even though the tax-exempt status of municipal bonds provides less of a subsidy to municipal capital than is traditionally thought, the revenue cost of this tax-exempt status is also less than traditionally thought.
