The 2017 Tax Cuts and Jobs Act (TCJA) brought about significant changes to the U.S. tax landscape, one of which was the capping of the state and local tax (SALT) deduction. This cap limited the amount of state and local taxes that taxpayers could deduct on their federal income tax returns. A recent study by Professor of Accounting Mikhail Pevzner and his co-authors Alan Reinstein, Matthew Wynter, and Tong Yao (2025) has examined the impact of this change on municipal bond pricing.
Municipal bonds are a crucial source of funding for local governments, used to finance everything from daily operations to major construction projects. The interest earned on these bonds is often exempt from federal and state taxes, making them attractive to investors in higher tax brackets. However, the pricing of these bonds can be influenced by numerous factors, including the financial health of the issuing municipality.
In their research paper titled, "The impact of capping the SALT deduction on municipal
bond pricing," the team focused on how the SALT deduction cap affected the relationship
between municipal bond yields and local real estate tax revenues.
Prof. Pevzner explained that “given that local real estate taxes are both a primary component of the SALT deduction and a crucial source of municipal revenue, the TCJA's impact on local government finances remains uncertain.”
The study suggests that the SALT cap has led to increased uncertainty around municipalities' ability to collect property taxes. This uncertainty, in turn, has influenced the pricing of municipal securities.
One of the key findings of the research is that municipal bond yields have become less sensitive to local real estate tax revenues following the implementation of the SALT deduction cap. This suggests that the market is now placing less emphasis on property tax revenues as an indicator of a municipality's ability to meet its debt obligations.
Moreover, the study reveals that this effect is more pronounced in counties where residents are less likely to support tax increases. As the authors put it, “Our findings highlight that policymakers should account for such public financing externalities when crafting similar, future legislation.” This implies that in areas with strong anti-tax sentiment, the limitation on SALT deductions has a greater impact on how municipal bonds are priced.
The research also uncovers that voter support for local tax ballot proposals has declined following the enactment of the TCJA. This suggests that the changes in federal tax law have influenced local political dynamics, making it more challenging for municipalities to raise funds through property taxes.
The study provides valuable insights into the intricate relationship between federal
tax policies and municipal finance. The findings underscore the importance of considering
the broader implications of tax legislation on local governments and their ability
to fund public services. As the authors state, "Our study contributes to several streams
of accounting and municipal finance research," highlighting the multifaceted impact
of the Tax Cuts and Jobs Act (TCJA)
on public financing costs and political uncertainty in local governance.
Citation
Pevzner, M., Reinstein, A., Wynter, M., & Yao, T. (2025). The impact of capping the SALT deduction on municipal bond pricing. Journal of Accounting and Public Policy, 51, 107312.
Full access to the paper courtesy of the publisher is available until May 30, 2025.
