In response to the explosive growth in private activity bond volume beginning in the 1970s, the Tax Reform Act of 1986 imposed state-by-state limitations (volume caps) on the issuance of most private activity tax-exempt bonds. Private activity bonds help finance mortgages, industrial development and student loans, among other activities. This paper estimates the effects of the volume caps on state and local borrowing in 1989 and 1990. We find that the volume caps do constrain private activity bond issuance in many states, especially in the more populous ones. No evidence is found to support the idea that private activity bonds help finance capital spending by state and local governments. The volume cap and other changes in the 1986 Tax Act have not resulted in a large substitution of taxable for tax-exempt financing on the part of state and local governments.
