Did Steve Forbes scare the US municipal bond market?

Abstract

This paper investigates the relationship of the daily spread between taxable and municipal securities to a daily indicator of the likelihood of a tax reform that would eliminate the preference now accorded to municipal securities, the ‘flat tax.’ The probability of tax reform is proxied by the market price of the shares of Steve Forbes, a champion of the flat tax, in the Iowa Electronic Market. We find evidence that the indicator of tax reform’s prospects was correlated with a decline in the spread on five and ten-year maturity bonds, although not for 30-year maturity bonds. The correlations do not, however, survive in first-difference form, suggesting either that Forbes’ prospects did not immediately affect expectations of future tax policy, that the correlations are coincidental rather than causal, or that the decreased signal-to-noise ratio obscures a real, but small, causal relationship.