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Taxes and tax-exempt bonds: A literature review

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This article reviews and synthesizes the academic literature on income tax exemptions for interest income derived from state and local (municipal) bonds. It explores a large body of work that evaluates the impact of federal and state tax exemptions on the borrowing costs of state and local governments. It also considers how the tax exemption influences municipal financing decisions, its distributional impacts, and potential for tax arbitrage schemes. It concludes with a discussion of the viability of eliminating the tax exemption entirely or transitioning the preference to a tax credit mirroring municipal bonds sold under the Build America Bond (BAB) program.

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