The Cost of Tax Policy Uncertainty

Abstract

Using the implied marginal forward tax rate and limited empirical data, the author estimates the tax risk premium at roughly 60 basis points, translating into a current market price of tax policy uncertainty of approximately $8 billion per year in the form of a burden imposed on the tax-exempt market. This additional cost also represents potential lost tax revenues to the federal government. The research extracts the market price of tax policy risk embedded in municipal swaps data, using tax-exempt and taxable swap rates. The implied marginal forward tax rate is useful for both municipal finance directors seeking to establish optimal debt policy and researchers seeking to explain the term structure of municipal interest rates. Bond market investors, tax-exempt issuers, and government policymakers may also find the implied marginal forward tax rate useful.