How does the cost of taxable debt usually compare to tax-exempt debt?

The cost of taxable debt is usually higher because of tax implications. This is largely due to the fact that interest on taxable debt is subject to federal income tax, which directly affects the yield that investors demand. Consequently, issuers need to offer a higher interest rate to attract investors to compensate for the tax liabilities associated with that interest income.

Conversely, tax-exempt debt (such as municipal bonds) is not subject to federal income tax, making it more attractive to investors who seek to retain more of their earnings after taxes. This allows municipalities and other issuers of tax-exempt debt to offer lower interest rates compared to their taxable counterparts, as investors may be willing to accept a lower yield in exchange for the tax benefits.

While there may be variations based on specific market conditions or the perceived risk of an issuer, the general rule remains: the tax implications of taxable debt necessitate higher costs to attract investors compared to tax-exempt debt.