How Do Municipal Bonds Behave Without Tax-Exemption?

We analyze an extensive sample of tax-exempt and taxable municipal bonds to better understand how municipals behave without federal tax-exemption. We find taxable municipals are issued at higher yields in high state tax rate jurisdictions, are less likely to be issued in these areas, and more likely to be issued in jurisdictions which tax in-state issues. This suggests tax premium and market segmentation effects. As state tax treatment becomes more important these effects may inhibit efficient portfolio diversification outcomes. This paper offers insight on how municipal portfolios and the municipal market behave in the absence federal tax exemption