Municipal Debt and Marginal Tax Rates: Is There a Tax Premium in Asset Prices?



    Search for more papers by this author
    • Francis A. Longstaff is with the UCLA Anderson School and NBER. I am very grateful for helpful discussions with Hanno Lustig, Douglas Montague, Eric Neis, Mike Rierson, Derek Schaeffer, and Joel Silva, and for the comments of seminar participants at UCLA. I am particularly grateful for the comments and suggestions of the Editor, Campbell Harvey, and of an anonymous referee, and for research assistance provided by Scott Longstaff and Karen Longstaff. All errors are my responsibility.


We study the marginal tax rate incorporated into short-term municipal rates using municipal swap market data. Using an affine model, we identify the marginal tax rate and the credit/liquidity spread in 1-week tax-exempt rates, as well as their associated risk premia. The marginal tax rate averages 38.0% and is related to stock, bond, and commodity returns. The tax risk premium is negative, consistent with the strong countercyclical nature of after-tax fixed-income cash flows. These results demonstrate that tax risk is a systematic asset pricing factor and help resolve the muni-bond puzzle.