The exemption of coupon payments by state and local governments from
federal income taxes in the United States is examined from the vantage point of
its effects on resource allocation—that is, its impact on the consumer's choice
between goods produced privately and goods produced by the local government
sector, on the choice between capital and labor in each sector, and on the
relative prices of both goods and factors of production. The results raise
questions about the value of tax exemption as a method of subsidizing local
government provision of services.
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