Private Activity Bonds as Investment Subsidy: Evidence from the 1986 Cap on Bond Volumes

I examine firms’ investment response to the supply of private activity bonds (PABs) – a subsidy tool granting corporate beneficiaries access to the tax-exempt municipal bond market. I leverage the variation in PAB supply limits across states introduced by the 1986 Tax Reform. By documenting a significant positive investment effect, I show that higher PAB supply stimulates firm investment. Although PABs subsidize capital over labor, my results do not support input factor substitution, as I find a positive effect on employment. I exploit the random outcome of a lottery-based PAB distribution mechanism to show that states’ project selection does not drive the results.