Voter-Induced Municipal Credit Risk.

This article examines how a policy shock—in particular, the reduction in state and local tax (SALT) deductions caused by the 2017 Tax Cuts and Jobs Act (TCJA)—increased the effective cost of local public goods for residents and consequently affected municipal credit risk. Using a difference-in-differences approach on secondary market municipal bond trades, the study finds that jurisdictions with a larger share of residents who stopped deducting SALT experienced significant increases in municipal bond yields, averaging an 8.3 basis point rise, or about 3.0% of the average yield spread. This effect is notably stronger in jurisdictions where voters have direct approval power over local tax increases and bond issuance, indicating that voter preferences and political empowerment influence municipal credit risk pricing. The findings are robust to various controls and alternative specifications, highlighting the role of voter-induced risk and coordination challenges in local public finance.