FACTORS ACCOUNTING FOR THE SHARPLY INCREASED COST OF STATE AND LOCAL GOVERNMENT BORROWING*

Abstract

DUPUNG THE ALMOST UNBROKEN boom of the postwar decade interest rates increased considerably. The largest relative increase for any major long-term yield, however, was that experienced in state and local government borrowing. The basic long-term yield on high-grade issues of this type more than tripled from the spring of 1946 to the close of 1956: an increase from 1 to more than 3 per cent. Short-term taxexempt yields went up relatively even more, as was true of all shortterm interest rates. Because the underwriting margins required in the turbulent markets near the end of the decade also increased, the costs of borrowing by state and local governmental units more than tripled. Such an increase in interest costs meant that the total amortization cost of a twenty-year serial debt with equal maturities had increased by more than a fifth; for a similar thirty-year debt the total amortization cost had increased by almost a third. This increase was generally blamed on restrictive monetary policies. The strong demand for funds unquestionably increased interest rates; it was so insistent that without monetary restriction it would have induced a degree of monetary expansion inconsistent with stable prices or a sustainable rate of economic growth. But this line of analysis explained only the general interest-rate increase; the unusual rise in taxexempt yields had to be explained by other factors. Evidence developed in the Postwar Capital Market study suggests that the reduced marginal value of tax exemption appears to have been that factor. The proportion of investors for whom tax exemption is of value had shrunk; while the volume of new money offerings had grown greatly. To find markets for the considerably increased volume of offerings, the privilege of tax exemption had to be bargained away for less and less. The faster rate of increase in tax-exempt yields was also accompanied by differences in maturity-yield patterns. The purpose of this paper is to isolate the factors uniquely related to tax exemption