[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
HEARING ON THE USE OF
TAX-PREFERRED BOND FINANCING
=======================================================================
HEARING
before the
SUBCOMMITTEE ON SELECT REVENUE MEASURES
of the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
MARCH 16, 2006
__________
Serial No. 109-56
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
30-622 WASHINGTON : 2006
------------------------------------------------------------------
For sale by Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2250. Mail: Stop SSOP,
Washington, DC 20402-0001
COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
E. CLAY SHAW, JR., Florida CHARLES B. RANGEL, New York
NANCY L. JOHNSON, Connecticut FORTNEY PETE STARK, California
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM MCCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM MCDERMOTT, Washington
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. MCNULTY, New York
PHIL ENGLISH, Pennsylvania WILLIAM J. JEFFERSON, Louisiana
J.D. HAYWORTH, Arizona JOHN S. TANNER, Tennessee
JERRY WELLER, Illinois XAVIER BECERRA, California
KENNY C. HULSHOF, Missouri LLOYD DOGGETT, Texas
RON LEWIS, Kentucky EARL POMEROY, North Dakota
MARK FOLEY, Florida STEPHANIE TUBBS JONES, Ohio
KEVIN BRADY, Texas MIKE THOMPSON, California
THOMAS M. REYNOLDS, New York JOHN B. LARSON, Connecticut
PAUL RYAN, Wisconsin RAHM EMANUEL, Illinois
ERIC CANTOR, Virginia
JOHN LINDER, Georgia
BOB BEAUPREZ, Colorado
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
DEVIN NUNES, California
Allison H. Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
______
SUBCOMMITTEE ON SELECT REVENUE MEASURES
DAVE CAMP, Michigan, Chairman
JERRY WELLER, Illinois MICHAEL R. MCNULTY, New York
MARK FOLEY, Florida LLOYD DOGGETT, Texas
THOMAS M. REYNOLDS, New York STEPHANIE TUBBS JONES, Ohio
ERIC CANTOR, Virginia MIKE THOMPSON, California
JOHN LINDER, Georgia JOHN B. LARSON, Connecticut
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisory of February 27, 2006 announcing the hearing............. 2
WITNESSES
Shaw, Hon. E. Clay Jr., a Representative in Congress from the
State of Florida............................................... 5
Brady, Hon. Kevin, a Representative in Congress from the State of
Texas.......................................................... 9
______
U.S. Department of the Treasury, Eric Solomon, Acting Deputy
Assistant Secretary for Tax Policy............................. 11
Congressional Budget Office, Donald Marron, Ph.D., Acting
Director....................................................... 25
Government Finance Officers Association, Carla Sledge............ 33
______
National Association of Bond Lawyers, Walter St. Onge, III....... 40
The Bond Market Association, Micah Green......................... 44
SUBMISSIONS FOR THE RECORD
Aeration Industries International, Chaska, MN, Dan Durda, letter. 58
American Forest and Paper Association, David Koenig, statement... 58
American Public Power Association, statement..................... 61
Clark, Jonathan, Hach Company, Loveland, CO, letter.............. 65
Durda, Dan, Aeration Industries International, Chaska, MN, letter 58
Egger, Fritz, JWC Environmental, Costa Mesa, CA, letter.......... 65
Environment One Corporation, Niskayuna, NY, Philip Welsh, letter. 64
Flowserve, Taneytown, MD, James Sivigny, letter.................. 64
Hach Company, Loveland, CO, Jonathan Clark, letter............... 65
JWC Environmental, Costa Mesa, CA, Fritz Egger, letter........... 65
Koenig, David, American Forest and Paper Association, Tax Exempt
Bonds Recycling Coalition, statement........................... 58
Large Public Power Council, Noreen Roche-Carter, letter.......... 66
National Association of Higher Educational Facilities Authorities
and National Council of Health Facilities Finance Authorities,
joint letter................................................... 69
National Association of Local Housing Finance Agencies, statement 70
National Association of Water Companies, statement............... 73
National Council for Public-Private Partnerships, statement...... 75
National Council of Health Facilities Finance Authorities and
National Association of Higher Educational Facilities
Authorities, joint letter...................................... 69
National Council of State Housing Agencies, Barbara Thompson,
statement...................................................... 75
Rebori, Robert, Smith and Loveless, Inc., Lenexa, KS, letter..... 79
Roche-Carter, Noreen, Large Public Power Council, letter......... 66
Simons, Steven, Wellesley, MA, statement......................... 78
Sivigny, James, Floweserve, Taneytown, MD, letter................ 65
Smith and Loveless, Inc., Lenexa, KS, Robert Rebori, letter...... 79
Tax Exempt Bonds Recycling Coalition, David Koenig, statement.... 58
Thompson, Barbara, National Council of State Housing Agencies,
statement...................................................... 75
U.S. Conference of Mayors, statement............................. 80
Water and Wastewater Equipment Manufacturers Association, Inc.,
statement...................................................... 82
Water Partnership Council, statement............................. 83
Welsh, Philip, Environment One Corporation, Niskayuna, NY, letter 64
HEARING ON THE USE OF
TAX-PREFERRED BOND FINANCING
----------
THURSDAY, MARCH 16, 2006
U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Select Revenue Measures,
Washington, DC.
The Subcommittee met, pursuant to notice, at 10:31 a.m., in
room 1100, Longworth House Office Building, Hon. Dave Camp
(Chairman of the Subcommittee), presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
SUBCOMMITTEE ON SELECT REVENUE MEASURES
CONTACT: (202) 226-5911
FOR IMMEDIATE RELEASE
February 27, 2006
SRM-6
Camp Announces Hearing on
The Use of Tax-Preferred Bond Financing
Congressman Dave Camp (R-MI), Chairman, Subcommittee on Select
Revenue Measures of the Committee on Ways and Means, today announced
that the Subcommittee will hold a hearing on the use of tax-preferred
bond financing. The hearing will take place on Thursday, March 16,
2006, in the main Committee hearing room, 1100 Longworth House Office
Building, beginning at 10:30 a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only. However,
any individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Subcommittee and
for inclusion in the printed record of the hearing.
BACKGROUND:
The Tax Reform Act of 1986 (the ``1986 Act'') (P.L. 99-514) made
significant modifications to the rules for tax-exempt bonds in an
effort to limit the use of tax-preferred bond financing to support
private activities. Many of the rules enacted as part of the 1986 Act
reflect the intent to limit bond financing to those activities that
were viewed to have a significant public benefit.
The last 20 years have seen an expansion of the use of tax-
preferred bond financing through increases in the amount of private
activity bonds that States can issue and the addition of activities
that qualify for tax-preferred bond financing. Most recently,
legislation has been enacted to provide tax-exempt and tax-credit bond
financing to assist in the Hurricane Katrina recovery and rebuilding
efforts. Furthermore, additional proposals to further expand the
availability of tax-preferred bond financing to other activities emerge
on a regular basis.
In announcing the hearing, Chairman Camp stated, ``In recent years,
there has been an expansion of the permitted uses of tax-preferred bond
financing. This hearing provides an opportunity for us to
comprehensively review this area to determine how this financing is
used today.''
FOCUS OF THE HEARING:
The purpose of this hearing is to undertake a comprehensive review
of tax-preferred bond financing to determine:
(i) the relative economic efficiencies and costs to the Federal
Government of financing activities through tax-exempt and tax-credit
bonds;
(ii) whether tax-preferred bond financing supports business
activities offering a significant public benefit;
(iii) the effect of the expansion of the use of tax-preferred bond
financing on the ability to properly prioritize those activities most
deserving of such financing; and
(iv) the effect of such expansion on the ability to oversee and
administer the use of tax-preferred bond financing.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Please Note: Any person(s) and/or organization(s) wishing to submit
for the hearing record must follow the appropriate link on the hearing
page of the Committee website and complete the informational forms.
From the Committee homepage, http://waysandmeans.house.gov, select
``109th Congress'' from the menu entitled, ``Hearing Archives'' (http:/
/waysandmeans.house.gov/Hearings.asp?congress=17). Select the hearing
for which you would like to submit, and click on the link entitled,
``Click here to provide a submission for the record.'' Once you have
followed the online instructions, completing all informational forms
and clicking ``submit'' on the final page, an email will be sent to the
address which you supply confirming your interest in providing a
submission for the record. You MUST REPLY to the email and ATTACH your
submission as a Word or WordPerfect document, in compliance with the
formatting requirements listed below, by close of business Thursday,
March 30, 2006. Finally, please note that due to the change in House
mail policy, the U.S. Capitol Police will refuse sealed-package
deliveries to all House Office Buildings. For questions, or if you
encounter technical problems, please call (202) 225-1721.
FORMATTING REQUIREMENTS:
The Committee relies on electronic submissions for printing the
official hearing record. As always, submissions will be included in the
record according to the discretion of the Committee. The Committee will
not alter the content of your submission, but we reserve the right to
format it according to our guidelines. Any submission provided to the
Committee by a witness, any supplementary materials submitted for the
printed record, and any written comments in response to a request for
written comments must conform to the guidelines listed below. Any
submission or supplementary item not in compliance with these
guidelines will not be printed, but will be maintained in the Committee
files for review and use by the Committee.
1. All submissions and supplementary materials must be provided in
Word or WordPerfect format and MUST NOT exceed a total of 10 pages,
including attachments. Witnesses and submitters are advised that the
Committee relies on electronic submissions for printing the official
hearing record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. All submissions must include a list of all clients, persons,
and/or organizations on whose behalf the witness appears. A
supplemental sheet must accompany each submission listing the name,
company, address, telephone and fax numbers of each witness.
Note: All Committee advisories and news releases are available on
the World Wide Web at http://waysandmeans.house.gov.
The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
business days notice is requested). Questions with regard to special
accommodation needs in general (including availability of Committee
materials in alternative formats) may be directed to the Committee as
noted above.
Chairman CAMP. Good morning. The hearing will come to order
and I'd ask our guests to find seats please. Good morning, as
part of The Committee on Ways and Means's continuing
exploration of tax-exempt options, Chairman Thomas asked the
Subcommittee on Select Revenue Measure to undertake a
comprehensive review of the use of tax-preferred financing.
Responding to the Chairman's request provides this Subcommittee
with a valuable opportunity to examine an area that has seen
significant change since the Tax Reform Act of 1986.
So, in this regard the last 20 years have seen an expansion
in the use of tax-preferred bond financing through increases in
private activity bonds that states can issue and the addition
of activities that qualify for tax-preferred bond financing.
Most recently, legislation has been enacted to provide tax-
exempt tax credit bond financing to assist in the Hurricane
Katrina recovery and rebuilding efforts. Furthermore,
additional proposals to further expand the availability of tax-
preferred bond financing to other activities emerge on a
regular basis.
The treatment and use of tax-preferred bond financing will
be an important consideration in the full Committee's
evaluation of the many options to reform the Federal Tax Code.
I want to welcome our witnesses' views on these important
issues, and the Chair now recognizes the Ranking Member, Mr.
McNulty, for a statement.
Mr. MCNULTY. Thank you, Mr. Chairman. I ask unanimous
consent to submit the text of my own statement for the record.
Chairman CAMP. Without objection.
[The prepared statement of Mr. McNulty follows:]
Opening Statement of The Honorable Michael R. McNulty, a Representative
in Congress from the State of New York
Today, the Subcommittee on Select Revenue Measure begins the second
session of the 109th Congress with a hearing on tax-preferred bond
financing. I am pleased that the Committee is acting to followup on
Chairman Thomas' promise to conduct a comprehensive review of how tax-
exempt bonds and tax-credit bonds have been used to finance public and
private activities.
States and localities have an outstanding record in the use of tax-
preferred financing. Tax-exempt bonds support many important community
priorities, including financing for our public schools, airports,
roads, hospitals, veterans' housing, water and sewage facilities,
hazardous waste disposal, and the low-income rental housing market. I
look forward to discussing how tax-exempt financing is being used by
our state and local governments and how their priorities in critically-
needed areas are being met.
In recent years, the Congress has enacted various tax provisions to
expand the availability of tax-preferred financing, including for
public school construction and renovation, energy conservation efforts,
and rebuilding following the hurricanes of 2005.
I thank Subcommittee Chairman Camp for scheduling this hearing. I
welcome all the witnesses appearing today and look forward to your
expert views on the issues before us.
I yield back the balance of my time.
Mr. MCNULTY. I just want to elaborate a little bit on that.
I know that questions have been raised on the use of tax-exempt
bonds through the years. My hope is, that as a result of this
hearing and subsequent action by the Subcommittee and the
Committee, that there is no retreat from financing projects
that advance the public good.
My experience as a Member of Congress and as a State
Legislator, and especially as a Mayor, has shown that tax-
exempt bonding has been used for vital projects, such as roads,
bridges, schools, hospitals, housing, airports, and energy
projects. I know there has been some question about the use
tax-exempt bonds for such things as high-speed rail.
I happen to believe that with the cost of fuel today and
the concerns about auto emissions and so on, that if ever there
was a time to move in that direction, the time is now.
I am concerned generally about the passenger rail system in
this country. I'll give an example. I live in Albany, New York,
and when I go to New York City, I certainly don't take the
plane to go down there, because you have to drive all the way
in there from the airport. I take the train and I ride down
that scenic route down the Hudson River, and then end up in
Midtown.
Part of the problem is when you get about 30 miles north of
New York City you have to slow down to about 40 miles an hour
because of the condition of the road bed. I think it's a
disgrace the way we've let rail service in this country
deteriorate through the years.
Another example, I lived in Italy for about a year back in
the sixties when I was going to school. The passenger rail
system in Europe in the sixties was better than then the
passenger rail service in The United States of America today.
Decades ago, other industrialized nations went to high-speed
trains and bullet-trains and we're still nickel-and-diming
Amtrak and I just think we need to change that.
In summary, Mr. Chairman, my position is that tax-exempt
bonding benefits states and local governments. It benefits the
purchasers of the bonds and it benefits the general public, and
it is a relatively small cost to the Federal Government. I
certainly think it's much better than Members of Congress
coming down here and asking for more earmarks, and I think that
we should continue to use and expand the use of tax-exempt
bonds. I hope, Mr. Chairman, we can affirm, and in some
instances expand the use of tax-exempt bonds for projects that
accrue to the public good.
Chairman CAMP. The Chair has been informed that we're going
to have a series of votes for at least an hour and a half. So,
what we're going to try to do is at least have our member
panel, as quickly as possible, make your remarks and then we'll
recess the Committee for this lengthy series of what may be up
to ten votes. We're grateful that two distinguished Members of
the Committee on Ways and Means are here, the Honorable E. Clay
Shaw, from Florida, and the Honorable Kevin Brady from Texas.
Congressman Shaw, why don't you begin your testimony and we'll
see how far we can get. You may begin.
Mr. SHAW. I will give you every bit of my cooperation to
expedite this process. I have a written statement that I ask
with unanimous consent be placed into the record.
Chairman CAMP. Without objection.
STATEMENT OF THE HONORABLE E. CLAY SHAW, JR., A REPRESENTATIVE
IN CONGRESS FROM THE STATE OF FLORIDA
Mr. SHAW. As a Mayor I know the problems of upgrading the
utilities, particularly with new Environmental Protection
Agency requirements. It's estimated that between five and six
hundred billion dollars will be necessary to upgrade the
utilities by the cities over the next several years. This
legislation that I have would encourage communities to find
willing partners in the private sector to finance these
infrastructure endeavors. It would in fact lift the cap for
these types of ventures.
The bill has a total cost over 10 years of 187 million
dollars, which is minute when you think about the gravity of
the problem. The bill is supported by 45 organizations,
including the U.S. Conference of Mayors, The National
Association of Counties, The National League of Cities, The
National Association of Towns and Townships. I think this is
exactly the type of help that we should send to cities and that
we do mandate these upgrades, and I yield back.
[The prepared statement of Mr. Shaw follows:]
Statement of The Honorable E. Clay Shaw, Jr., a Representative in
Congress from the State of Florida
Mr. Chairman, I appreciate the opportunity to testify today about
my Clean Water Investment and Infrastructure Security Act--H.R. 1708. I
am glad that the Subcommittee is holding this hearing on tax-preferred
bonds and their use to finance various public-private activities.
Our nation is facing a water infrastructure replacement challenge.
In 2002, the Environmental Protection Agency (EPA) estimated that
approximately $500--$600 billion will be needed through the end of this
decade to replace, upgrade or expand water and wastewater
infrastructure. This infrastructure is critical to the economic and
public health of our communities and the nation.
Older towns and cities in the north and east, and growing towns and
cities in the west and south are all facing major water infrastructure
challenges. The reason for this large need is an accident of history.
There have been several generations of water infrastructure put in
place in the U.S. over the last hundred years. The oldest
infrastructure was extremely long-lived but is now coming to the end of
its useful life or does not fulfill the current needs of the community.
Newer rounds of water infrastructure had shorter projected life spans
and are also coming to the end of their lives or need upgrading.
As a former mayor of Fort Lauderdale, Florida, I understand the
importance of rebuilding our infrastructure. Local governments are
cost-strapped and are in need of help. We have a tremendous opportunity
to impact our local municipalities on an issue of concern.
The challenge communities across the country are facing can largely
be addressed with good management and creative thinking. Willing
partners to finance these endeavors can be found in the private sector.
The federal government can do its part to facilitate this by lifting
the current volume cap on private activity bonds--which can be done
through the Clean Water Investment and Infrastructure Security Act--
H.R. 1708.
H.R. 1708 would bring water and wastewater projects out from under
the state volume caps on private activity bonds (PABs), and thereby
assist municipalities' accessing the private sector to responsibly
address the water infrastructure challenge. This simple change will
make capital both easier to obtain and less expensive for partnerships
between the public and private sector on water projects, thus making
such partnerships much more economically attractive to all concerned.
The goals of H.R. 1708 directly support and facilitate recent
initiatives by the EPA and many states and cities to develop
sustainable water and wastewater infrastructure systems based on sound
economic and asset management principles. The new projects initiated by
H.R. 1708 would benefit from innovative financing and project delivery
methods, and cities and citizens would see their challenges met more
efficiently and more quickly. Projects structured as public-private
partnerships using newly available PABs would optimize development,
construction and long-term operations--allocating and sharing risk and
management.
The Tax Reform Act of 1986 clearly identified public-purpose water
and wastewater facilities as two of only a few types of projects
undertaken in the public good to be eligible for PABs. However, the
1986 Act and its federally mandated state volume caps on the PABs
essentially force water projects to compete with other public projects,
including public housing, school loans and others for PABs. Data shows
that water projects generally lose this battle to more high-profile,
politically attractive activities like housing.
All of the projects eligible to use PABs may be worthy endeavors
that contribute to a community's growth and prosperity. Uniquely,
however, the water and wastewater infrastructure constructed is needed
to comply with federal requirements under the Clean Water Act and the
Safe Drinking Water Act.
My legislation would end this competition, bring water projects out
from under the cap, and unleash the power of the private sector to
assist our cities and towns water in meeting their infrastructure
replacement challenge. It has been estimated in the first few years
after H.R. 1708 is made law, $1 to $2 billion in water PABs would be
issued annually, and could double or triple over time.
We can look to the solid waste sector for further indications of
the potential of this simple change in the tax code. Municipal sold
waste disposal projects were pulled out from under the volume cap in
1986 to address the then serious public solid waste disposal challenge.
As a result, over $15 billion worth of PABs have been issued since, and
the problem has largely been solved.
Chart 1 shows the impact that this move made in using PABs and
innovative partnerships to create effective solutions to the nation's
solid waste needs of that time.
Transaction Amounts Over Past 25 Years
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Chart 1. Solid Waste Historical Data (Lehman Brothers)
In contrast, Chart 2 shows how little communities have been able to
access PABs to finance construction of facilities to address their
water and wastewater challenges. I believe we will see a response for
water similar to solid waste with enactment of H.R. 1708.
Transaction Amounts Over Past 25 Years
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Chart 2. Water/Wastewater Historical Data (Lehman Brothers)
When you factor in the cost/benefit of H.R. 1708 to the federal
government, it is easy to see that this is a correct path for Congress
to take. Legislation identical to H.R. 1708 was scored by Joint
Committee on Taxation in 2002, and was found to cost the federal
government $147 million over ten years. That is $147 million that the
federal government can invest over the next decade, and generate
several billion dollars for critical public purpose water facilities in
return every year.
I have requested that the Joint Committee on Taxation conduct a new
score of this legislation and hope to have it in hand soon.
So far, H.R. 1708 has attracted over 25 co-sponsors; roughly
equally from each side of the aisle including 6 Ways and Means
Committee members. It is also supported by over 30 organizations
including the U.S. Conference of Mayors, the National Association of
Counties, and the National Association of Towns and Townships.
There are those who believe the federal government needs to
establish a massive new grant program to address the water
infrastructure challenge. They further believe that this new
bureaucracy should be financed by a new ``user fee'' or tax of some
sort; and they may be coming to the Ways and Means Committee to
establish these new fees or taxes. I urge my colleagues to not go down
this path but instead respond to the infrastructure funding challenge
responsibly. H.R. 1708 is the preferred federal response because it:
1. Leverages limited federal resources;
2. Does not require massive reliance on scarce federal funds;
3. Does not require any new taxes or fees;
4. Does not subsidize utilities with a government handout, instead
gives them the tools to handle their problems themselves;
5. Leverages the power of the private sector to address the
problem with their proven efficiency and innovation, saving money for
the government, taxpayers, and water customers;
6. Does not require the average taxpayer to pay for services he/
she does not directly enjoy; and
7. Is far less likely to lead to over-built and wasteful projects
often seen in projects heavily reliant on government grants.
Thank you again for this opportunity to testify before you today. I
look forward to continuing to work with the Subcommittee on measures to
strengthen and improve the financing of projects beneficial to all
communities across the country.
Chairman CAMP. I thank the Gentleman, and I thank you for
your testimony, and your full statement will be part of the
record. Hon. Kevin Brady, another distinguished Member of the
Committee on Ways and Means.
STATEMENT OF THE HONORABLE KEVIN BRADY, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF TEXAS
Mr. BRADY. Thank you, Mr. Chairman and Ranking Member. I
would say, Mr. Shaw, you set the bar a little to high on that
brief statement. Let me try to be equally brief. I want to
thank you for hosting this, Mr. Chairman. I would like to speak
briefly about the tax-exempt financing for air and water
pollution equipment. I have introduced again to this Congress
the Clean Air and Water Investment Act to make these facilities
eligible for tax-exempt financing bonds.
They used to--prior to 1986, when it was taken out of the
Tax Act--but the problem is that more and more communities
around the country are facing very stringent timelines for
meeting clean air standards in America.
The deadline for most of our communities is 2010. Including
Michigan and New York, 38 states have communities that are now
out of compliance in one of those areas, ozone, carbon
monoxide, particulate matter. It is very expensive to do the
upgrades on this equipment for the community to meet these
standards.
My district has two of those communities, Houston and
Beaumont, both ozone related communities. For one of them,
Houston, it is estimated those upgrades will be about 15
billion dollars throughout our community to meet those
standards.
The solution is to give states additional tools, like air
and water control facility bonds, which would be based on need
and merit, to help them meet those standards on time and to do
it affordably.
What our bill would do is simply restore the exact same
language that existed in section 142 of the Internal Revenue
Service (IRS) Tax Code. It would keep the existing state volume
cap, so we wouldn't be adding activity levels. In fact, air and
pollution equipment would have to compete against the other
modern needs within the state, so we're not adding cost to the
process. We're giving them these tools and restoring the
category to the Code will allow states to prioritize their
compliance issues by granting these bonds.
So, we would not increase the amount of private activity
bonds, but we would provide that as a local tool. We know in
Texas, for example--many states use this--but we have 15
different projects, air and water projects, very key to
cleaning up our environment before 1986.
We also have a list of projects that we know would be
available today. I'll close with this. The benefit to restoring
the bonds is you accelerate the pollution improvements, bring
them about faster. You do so at less cost, so the community and
industries can use their dollars, whether it's for health care
costs for the workers or research and development to stay
competitive with other countries.
But we, in effect, reduce the costs of those facilities by
25 to 30 percent, while still meeting our clean air and clean
water goals around this country.
I have, Mr. Chairman, two documents, the list of states
that are in non-compliance, a list of the projects that are
examples of it, and my thought is that America helps finance
clean air and water projects all around the world. Why can't we
do the same in our own local communities? Thank you, Mr.
Chairman.
[The prepared statement of Mr. Brady follows:]
Statement of The Honorable Kevin Brady, a Representative in Congress
from the State of Texas
Mr. Chairman and distinguished Members of the Subcommittee, I am
delighted to be before you today to discuss a matter that is very
important to me--restoring tax-exempt financing eligibility for ``air
and water pollution control facilities'' to the United States tax code.
My district, and the entire State of Texas, need additional tools
for compliance with non-attainment issues related to implementation of
the Clean Air Act. In fact, communities on both the eastern and western
borders of my district--Beaumont and Houston, respectively--are in non-
attainment. I have been working hard for over five years on my own and
as a part of coalitions to effectuate this change and truly believe
that this hearing is a first important step toward making it a reality.
And, I would like to acknowledge the hard work of the Gulf Coast Waste
Disposal Authority whose General Manager, Board Chairman and Board
Members are with us in this room today. It was this group that
initially brought this provision to my attention and persuaded me of
the need to move forward.
Air and water pollution control facilities, one of thirteen tax-
exempt categories, were removed from the tax code in the Tax Reform Act
of 1986. Remarkably, in all of time I have been trying to restore their
eligibility status no one has ever been able to explain the reason for
their removal. Airports, docks and wharfs, mass commuting facilities,
facilities for the furnishing of water, sewage facilities, solid waste
facilities, public water pollution control facilities and many other
environment and infrastructure measures remained, but this one was
removed. It was removed, notwithstanding the fact that, prior to l986,
a large amount of the nation's progress in the reduction of the release
of pollutants into our air and water was directly tied to projects that
had been financed by private activity bonds for air and water pollution
facilities.
In the 109th Congress, I have once again introduced the ``Clean Air
and Water Investment Act'' to accomplish the objective of restoring air
and water pollution control facilities as an eligible tax-exempt
category. I have introduced this legislation in several forms over the
past few Congresses, but in this instance, it is a simple restoration
of prior tax code. The measure would restore the term air and water
pollution control facilities to Section 142 of the Internal Revenue
Code, but it would not in any way amend the provisions of Section 146
of the code relating to state volume caps on the use of tax-exempt
financing. Under my bill, tax-exempt bonds issued for air and water
pollution control would be under the existing caps and would not
increase the total amount of private activity state and local bond
issuance. They would, in fact, compete with other requests for tax-
exempt financing and only be approved if they were successful.
What I am trying to do is add--restore, really--a tool for state
and local governments to deal with the pressing needs demanded by
increased environmental regulations particularly those pursuant to the
Clean Air Act. The tool would aid in compliance through the
construction of new, required pollution control facilities, and the
repair of existing facilities, which, in Texas were severely damaged by
hurricane activities.
Every year the President's budget includes the estimated losses to
the federal government from all tax-exempt interest on municipal debt.
The total nationwide for Fiscal Year 2006 is estimated to be $34.86
billion including all categories. However, the revenue loss on an
annual basis for pollution control is estimated at $480 million or 1.4%
of the total of all tax-exempt bonds. This loss will grow slightly over
the next five years as populations increase and additional demands are
placed on state and local governments for pollution control activities.
The growth of bond issuance will occur whether or not this proposed
legislation is approved because there will be an increase in state caps
due to a natural increase in population.
But the demands are significant and the state and local governments
are in need of additional tools. According to the U.S. Environmental
Protection Agency, as of April 2005, there are 474 counties in thirty-
two states that cannot meet clean air standards as measured by the 8-
hour ozone criteria. Additional counties and states could be added to
the list if one includes other standards, such as carbon monoxide and
particulate standards. States are increasing their enforcement of the
total maximum daily loads (TMDLs) for water pollution creating more
burdens on the private sector to further clean up water pollution
discharges. This legislation would simply provide a financing tool not
currently available to the private sector to construct needed
facilities that will meet ever increasing air and water standards thus
reducing the burden on small businesses and protecting the health of
the general population.
In addition, we are all reading about the increasing demand for
safe drinking water free from contaminants for our growing population.
Much of the required infrastructure to meet the demand will come from
private-public partnerships. The private activity bonds that I am
proposing will provide an alternative that will reduce capital costs
and, in turn reduce the cost of safe, clean water to consumers.
In conclusion, Mr. Chairman let me state my appreciation to you and
to the committee for holding this important hearing. I stand ready to
assist you in any way that I can to move this important legislation
forward. Thank you. I will be happy to answer any questions that you
may have.
Chairman CAMP. Well thank you very much and your full
statement will be part of the record. Thank you both for your
excellent testimony, and that concludes our first panel and the
Committee will recess until we conclude votes on the floor.
Thank you very much.
[Recess]
Chairman CAMP. The hearing will come to order again. We
will begin with panel two, and we're honored to have Eric
Solomon, acting Deputy, Assistant Secretary to Tax Policy of
The U.S. Department of Treasury, and Donald Marron, Phd.,
acting Director to The Commission of The Congressional Budget
Office (CBO). Thank you both for being here. You have 5
minutes, Mr. Solomon, to give your statement. Your full
statement can be part of the record and you many begin.
STATEMENT OF ERIC SOLOMON, ACTING DEPUTY ASSISTANT SECRETARY OF
TAX POLICY, U.S. DEPARTMENT OF TREASURY
Mr. SOLOMON. Thank you Chairman Camp and distinguished
Members of the Subcommittee. I appreciate the opportunity to
discuss with you today some of the Federal tax issues
surrounding the use of tax-preferred bond financing. The
Administration recognizes that tax-preferred bond financing
plays a very important role as a source of financing to state
and local governments for critical public infrastructure
projects and other significant public purpose activities.
In talking about tax-preferred bonds, it is important to
keep in mind the difference between governmental bonds, the
proceeds of which directly finance the activities of state and
local governments, and qualified private activity bonds, which
typically benefit the private party in some way.
The cost to the Federal Government of tax-preferred bond
financing is significant. Unlike direct appropriations,
however, the cost often goes unnoticed, because it is not
tracked annually through the appropriations process.
In addition to the direct Federal revenue cost of providing
a tax-exemption or credit, there are also indirect costs, such
as administrative burdens on issuers and the IRS, in part
imposed by complex rules.
The steady growth in the volume of tax-preferred bonds and
Congressional proposals to expand them reflect their great
importance as incentives in addressing public infrastructure
and other needs. At the same time, however, it is appropriate
to review these programs to insure that they are properly
targeted and to insure that the Federal incentive is justified
in light of the revenue costs and other costs imposed.
Now, I would like to just highlight a few tax policy and
administrative issues raised by tax-preferred bonds. First, as
I previously mentioned in considering any expansion of any tax-
preferred bond financing, it is important to target the Federal
incentive carefully. When tax-preferred bonds are used to
finance necessary projects that would not be built without a
Federal incentive, the justification for the Federal incentive
is apparent. Where projects would have been built even without
a Federal incentive or where the broader public justification
for a project is absent, the Federal incentive can result in a
misallocation of capital.
Second, the allocation of the Federal incentive provided by
tax-preferred bond financing is most efficient when it is
provided for within the existing general framework of the tax-
exempt bond rules, rather than with additional specialized bond
regimes. The tax-exempt bond provisions have developed over the
past 20 years to insure proper targeting of the Federal
incentive.
Third, we have concerns about the Federal revenue costs
associated with providing a deeper level of incentive to tax
credit bonds than is provided to tax-exempt bonds. The deeper
Federal incentive provided in the three existing tax credit
bond programs is comparable to the Federal Government paying
the entire interest coupon on Double-A corporate bonds, which
is a larger Federal incentive provided to tax-exempt bonds.
In addition, tax credit bonds raise a number of
difficulties that offset the fact that they may be more
efficient than tax-exempt bonds in delivering a Federal
incentive. Concerns with tax credit bonds include a small
illiquid market, a less market driven pricing procedure
conducted by The Treasury Department, and many new
complexities. There is a complexity and awkwardness in having
parallel regulatory regimes for the large longstanding tax-
exempt bond program, and the various limited tax credit bond
programs.
Fourth, we believe that the unified annual state volume cap
on qualified private activity bonds generally has provided a
fair, flexible, and effective constraint on the volume of tax-
exempt private activity bonds. We have various concerns about
other volume cap allocation methods.
Fifth, we have administrative resource concerns with
special bond programs. The Treasury Department and the IRS are
increasingly charged with responsibility to regulate, allocate,
and audit unique special purpose bond issuances. They present
many administrative challenges and they require a
disproportionate allocation of administrative resources.
In conclusion, the Administration recognizes the very
important role that tax-preferred bond financing plays in
providing a source of financing for critical public
infrastructure projects and other significant public purpose
activities. When considering further expansions of tax-
preferred bond financing, it is important to insure that the
Federal incentive is properly targeted and used for its
intended purposes, and that the direct and indirect costs of
the Federal incentive are carefully considered in light of the
revenue costs and other costs imposed.
Thank you for the opportunity to appear before you on these
important matters, and I would be pleased to answer any
questions you may have.
[The prepared statement of Mr. Solomon follows:]
Statement of Eric Solomon, Acting Deputy Assistant Secretary for Tax
Policy, U.S. Department of the Treasury
Chairman Camp, Mr. McNulty and distinguished members of the
Subcommittee:
I appreciate the opportunity to discuss with you today some of the
Federal tax issues surrounding the use of tax-preferred bond financing.
There are two general types of tax-preferred bonds: tax-exempt bonds
(including governmental bonds and qualified private activity bonds) and
tax credit bonds. Tax-preferred bonds have long been an important tool
for State and local governments to finance public infrastructure and
other projects to carry out public purposes. The Federal government
provides important subsidies for tax-preferred bond financing that
significantly reduce borrowing costs for State and local governments,
most notably through the Federal income tax exemption afforded to
interest paid on tax-exempt bonds. While steady growth in the volume of
tax-preferred bonds and Congressional proposals to expand them reflect
their importance as incentives in addressing public infrastructure and
other needs, it is appropriate to review these programs to ensure that
they are properly targeted and to ensure that the Federal subsidy is
justified.
The first part of my testimony today will provide an overview of
existing types of tax-preferred bonds and summarize the current market
for these bonds. The second part of my testimony will give a basic
explanation of the Federal subsidy that is provided for each type of
tax-preferred bond. The third part of my testimony will describe
various technical rules in the tax law that ensure that the Federal
subsidy for tax-preferred bonds is used properly. The fourth part of my
testimony will summarize the recent growth in special purpose tax-
exempt bonds and tax credit bonds. The fifth and final part of my
testimony will highlight administrative and tax policy concerns that
are raised by the recent growth in special purpose bond financing.
Overview of Tax-Preferred Bonds
Governmental Bonds
State and local governments issue tax-exempt bonds to finance a
wide range of public infrastructure, including schools, hospitals,
roads, libraries, public parks, and water treatment facilities. The
interest paid on debt incurred by State and local governments on these
bonds is generally excluded from gross income for Federal income tax
purposes if the bonds meet certain eligibility requirements. There are
two basic kinds of tax-exempt bonds: governmental bonds and qualified
private activity bonds. Bonds generally are treated as governmental
bonds if the proceeds of the borrowing are used to carry out
governmental functions and the debt is repaid with governmental funds.
Under the general tax-exempt bond provisions of the Internal
Revenue Code (Code), bonds are classified as governmental bonds under a
definition that limits private business use and private business
sources of payment for the bonds and also limits financing of private
loans. Bonds that have excessive private involvement under this
definition are classified as ``private activity bonds,'' the interest
on which is tax-exempt only in limited circumstances.
In order for interest on tax-exempt bonds, including governmental
bonds, to be excluded from income, a number of specific requirements
must be met. Requirements generally applicable to all tax-exempt bonds
include arbitrage limitations, registration and information reporting
requirements, a general prohibition on any Federal guarantee, advance
refunding limitations, restrictions on unduly long spending periods,
and pooled bond limitations.
The total volume of new, long-term governmental bonds has grown
steadily since 1991, as shown in Figure 1. The Federal tax expenditures
associated with the income exclusion for interest on governmental bonds
has also grown over the years, as shown in Figure 3.
Private Activity Bonds.
Bonds are classified as ``private activity bonds'' if more than 10%
of the bond proceeds are both: (1) used for private business use (the
``private business use test''); and (2) payable or secured from private
sources (the ``private payments test''). Bonds also are treated as
private activity bonds if more than the lesser of $5 million or 5% of
the bond proceeds are used to finance private loans, including business
and consumer loans. The permitted private business thresholds are
reduced from 10% to 5% for certain unrelated or disproportionate
private business uses.
Private activity bonds may be issued on a tax-exempt basis only if
they meet the requirements for ``qualified private activity bonds,''
including targeting requirements that limit such financing to
specifically defined facilities and programs. For example, qualified
private activity bonds can be used to finance eligible activities of
educational and other charitable organizations described in section
501(c)(3). Tax-exempt private activity bond financing is also available
for certain qualified facilities such as airports, docks, wharves,
transportation infrastructure, utility and sanitation infrastructure,
low-income residential housing projects, and small manufacturing
facilities. Qualified private activity bonds may also be used to
finance home mortgages for veterans and to facilitate single-family
home purchases for first-time home buyers who satisfy income, purchase
price, and other qualifications.
Qualified private activity bonds are subject to the same general
rules applicable to governmental bonds, including the arbitrage
investment limitations, registration and information reporting
requirements, the Federal guarantee prohibition, restrictions on unduly
long spending periods, and pooled bond limitations. Most qualified
private activity bonds are also subject to a number of additional rules
and limitations, in particular the volume cap limitation under section
146 of the Code.
Unlike the tax exemption for governmental bonds, the tax exemption
for interest on most qualified private activity bonds is generally
treated as an alternative minimum tax (AMT) preference item, meaning
that the tax preference for these bonds is often taken away by the AMT.
The current private activity bond regime was enacted as part of the
Tax Reform Act of 1986 and was designed to limit the ability of State
and local governments to act as conduit issuers in financing projects
for the use and benefit of private businesses and other private
borrowers. Prior to enactment of this regime, States and municipalities
were subject to more liberal rules governing tax-exempt ``industrial
development bonds,'' the proceeds of which could be used for the
benefit of private parties. The dramatic impact that enactment of the
private activity bond regime in 1986 had on the volume of tax-exempt
bonds benefiting private parties is reflected in Figure 4.
The total volume of new, long-term qualified private activity bonds
issued since 1991 is shown in Figure 1. In 2003, the most recent year
for which the Internal Revenue Service Statistics of Income (SOI)
division data are available, approximately $200 billion in tax-exempt
bonds were issued, 22 percent of which were private activity bonds.
Between 1991 and 2003, private activity bonds accounted for an average
of 27 percent of total annual tax-exempt bond issuances.
Figure 2 shows the allocation of private-activity bonds among
various qualified projects and activities. As can be seen, the largest
issuance category in 2003 was tax-exempt hospitals, followed by non-
profit education, rental housing, airports and docks, mortgages, and
student loans. Tax expenditure estimates for tax-exempt bond issues
between 1996 and 2005 are shown in Figure 3.
Tax Credit Bonds
Tax credit bonds are a relatively new type of tax-preferred bond
that differ from governmental or qualified private activity bonds in
that the economic equivalent of ``interest'' is paid through a taxable
credit against the bond holder's Federal income tax liability. Tax
credit bonds are designed to be ``zero coupon'' bonds that pay no
interest. Recent programs for tax credit bonds encompass less than $5
billion in total authorized or outstanding issues. By comparison, the
tax-exempt bond market (including governmental and qualified private
activity bonds) encompassed over $2 trillion in outstanding issuances
as of the end of 2005.
In general, the Federal subsidy provided to tax credit bonds is
``deeper'' than that provided to tax-exempt bonds. In simplified terms,
the Federal subsidy to State and local governments on tax credit bonds
is equivalent to the Federal government's payment of interest on those
bonds at a taxable rate. By comparison, the Federal subsidy on tax-
exempt bonds is equivalent to the Federal government's payment of the
interest differential between taxable and lower tax-exempt interest
rates as a result of the exclusion of the interest from income for most
Federal income tax purposes.
Existing law provides for three types of tax credit bonds,
Qualified Zone Academy Bonds (``QZABs''), Clean Renewable Energy Bonds
(``CREBs'') and Gulf Opportunity Zone Tax Credit Bonds (``GO Zone Tax
Credit Bonds''), each of which is described in more detail below.
Federal Subsidy for Tax-Exempt Bonds and Tax Credit Bonds
A rationale for Federal subsidization of local public projects and
activities exists when they serve some broader public purpose. The most
straightforward means of delivering this subsidy is through direct
Federal appropriations for grants to State and local governments. The
tax exemption for interest paid on tax-exempt bonds, and the interest
equivalent paid on tax credit bonds, are alternative means of
delivering a Federal subsidy. The policy justification for delivering
these subsidies, whether through direct appropriations, a tax
exemption, or a tax credit, is weakened, however, as use of the
proceeds gets further away from traditional governmental purposes.
Subsidy for Tax-Exempt Bonds
The Federal government's exemption of the interest on certain bonds
from income tax lowers the rate of interest that investors are willing
to accept in order to hold these bonds as compared to taxable bonds,
thereby lowering State and local governmental borrowing costs.
Governmental bonds also often have tax exemptions for various State tax
purposes. The amount of the Federal subsidy enjoyed by State and local
governments depends on the overall supply and demand for tax-exempt
bonds and on the marginal tax bracket of the investor holding the
bonds. For example, if taxable bonds yield 10 percent and equivalent
tax-exempt bonds yield 7.5 percent, then investors whose marginal
income tax rates exceed 25 percent will prefer to invest in tax-exempt
bonds. On an after-tax basis, these investors will be better off giving
up the extra 2.5 percent yield on a taxable bond in exchange for a
greater than 25 percent reduction in their income tax liability for
each dollar in tax-exempt interest they receive. At the same time, the
State or local government issuing the bond will enjoy a 25 percent
reduction in its borrowing costs.
This ``tax wedge'' between the tax-exempt and taxable bond interest
rates highlights the inefficiency of the Federal subsidy provided by
tax-exempt bond financing. Investors whose marginal tax brackets exceed
the prevailing tax wedge (25 percent in the example above) reap a
windfall from investing in tax-exempt bonds, because they would have
been willing to accept a lower interest rate to hold tax-exempt debt.
Therefore, although tax-exempt issuers spend less on interest than they
would if they had to issue taxable debt, they nonetheless spend more on
interest than they would if they were able to pay each investor just
enough to make him hold tax-exempt debt. The size of the windfall to
high-bracket investors can be large: since 1986, the average tax wedge
between long-term tax-exempt bonds and high-quality corporate bonds has
been about 21 percent, well below the top marginal personal income tax
rates of 28 to 39.6 percent during that period. The Federal government
pays this premium through a tax exemption.
Subsidy for Tax Credit Bonds
Tax credit bonds provide a Federal tax credit that is intended to
replace a taxable interest coupon on the Bonds. Existing tax credit
bond programs provide that the credit rate is based on a taxable AA
corporate bond rate at the time of pricing. In theory, an investor who
has sufficient Federal tax liability to use the credit will have a
demand for a tax credit bond. Tax credit bonds are more efficient than
tax-exempt bonds, although unlike tax-exempt bonds they shift the
entire interest cost to the Federal government.
Instead of having cash coupons, tax credit bonds provide tax
credits (at a taxable bond rate), which are added to the investor's
taxable income and then subtracted from the investor's income tax
liability. For example, if the taxable rate is 10 percent, a $1,000
bond would yield $100 in tax credits. If the investor were in the 35
percent tax bracket, he would include $100 in income and pay an extra
$35 in tax (before the credit). He would then take the $100 credit
against this total tax bill, for a net reduction in tax liability of
$65. For investors with sufficient positive tax liabilities to utilize
the full value of the credit, tax credit bonds are equivalent to
Federal payment of interest at a taxable interest rate. Thus, an
investor who received $100 in taxable interest and paid $35 in tax
would have $65 in hand after taxes. Similarly, the holder of a tax
credit bond who receives $100 in credits would, after paying $35 in tax
on those credits, end up with $65 more in hand after taxes.
From an economic perspective, the Federal subsidy for tax credit
bonds may be viewed as more efficient than the subsidy for tax-exempt
bonds. This is because the Federal subsidy for tax credit bonds is
based on taxable interest rates and an investor may have a demand for
tax credit bonds so long as the investor has sufficient Federal tax
liability to use them. By comparison, the Federal subsidy for tax-
exempt bonds may be viewed as inefficient in the sense that the tax-
exempt bond market does not pass the full Federal revenue cost to State
and local governments through correspondingly lower tax-exempt bond
rates. As discussed in more detail below, however, tax credit bonds
have a number of practical inefficiencies that may outweigh any
economic advantage they have in delivering a Federal subsidy.
Rules Governing Tax-Preferred Bonds
Federal tax law contains a number of detailed rules governing tax-
exempt bonds that reflect a longstanding, well developed regulatory
structure. Additional rules provide detailed targeting and other
restrictions for qualified private activity bonds. In contrast, the
three existing tax credit bond programs provide disparate statutory
rules with varying incorporation of the general tax-exempt bond rules.
Rules of General Applicability to Tax-Exempt Bonds.
Arbitrage Yield Restrictions and Arbitrage Rebate. In order to
properly target the Federal subsidy for projects financed with tax-
exempt bonds, the Code contains arbitrage rules that prevent State and
local governments from issuing more bonds than necessary for a
particular project, or from issuing bonds earlier or keeping bonds
outstanding longer than necessary to finance a project. Subject to
certain exceptions, these ``arbitrage yield restrictions'' limit the
ability of State and local governments to issue tax-exempt bonds, any
portion of which is reasonably expected to be invested in higher-
yielding investments. The arbitrage rules also require that certain
excess earnings be paid to the Federal government (the ``arbitrage
rebate'' requirement).
Advance Refunding Limitations. The Code contains detailed ``advance
refunding'' limitations designed to limit the circumstances in which
more than one tax-exempt bond issuance is outstanding at the same time
for the same project or activity. Refunding bonds are often issued to
retire outstanding debt in an environment of declining interest rates.
Limitations on the ability to ``call'' outstanding debt often lead to
circumstances in which issuers seek to do advance refundings. In an
advance refunding, the issuer uses proceeds from refunding bonds to
defease its obligation on the original ``refunded bonds,'' but does not
pay off the refunded bonds until more than 90 days after the refunding
bonds are issued.
Advance refundings are inefficient and costly to the Federal
government because they result in more than one Federal subsidy being
provided for the same project at the same time. In 2002 and 2003, when
interest rates were falling, current refundings and advance refundings
accounted for 40 percent and 36 percent of total governmental bond
issuances, respectively. By contrast, in 2000, a year of relatively
high interest rates, advance refundings accounted for 20 percent of
total governmental bond issuances.
Prior to the Tax Reform Act of 1986, advance refundings were a
greater concern because issuers could advance refund governmental bonds
an unlimited number of times. The Code now generally permits only one
advance refunding for governmental bonds and prohibits advance
refundings entirely for qualified private activity bonds other than
qualified 501(c)(3) bonds. Less restrictive rules apply to ``current
refundings'' in which the refunded bonds are fully retired within 90
days after the issuance of the refunding bonds.
Prohibition Against Federal Guarantees. Under the Code, interest
paid on bonds that carry a direct or indirect Federal guarantee is
generally not excluded from income. The broad prohibition against
Federal guarantees of tax-exempt bonds is designed to avoid creating a
tax-exempt security that is more attractive to investors than Treasury
securities because it has both the credit quality of a Treasury
security and a Federal tax exemption. There are a limited number of
exceptions to the prohibition on a Federal guarantee, most of which
date back to enactment of the Federal guarantee prohibition in 1984.
Registration Requirement and Information Reporting. In order to
ensure the liquidity of tax-preferred bonds in the financial markets
and to prevent abuse through use of bearer bonds, most tax-exempt bonds
are subject to registration requirements. In addition, issuers of these
bonds must file certain information returns with the IRS at the time of
issuance of the bonds in order for the interest to be tax exempt or for
the holder of a tax credit bond to claim the credit.
Hedge Bond Restrictions. ``Hedge bond'' provisions generally
prohibit the issuance of tax-exempt bonds in circumstances involving
unduly long spending periods in which issuers cannot show reasonable
expectations to spend most of the bond proceeds within a five-year
period.
Pooled Bond Financing Limitations. ``Pooled bond'' financing
limitations generally impose restrictions on the use of tax-exempt
bonds in pooled bond financings involving loans of bond proceeds to two
or more borrowers. These restrictions are designed to encourage prompt
use of the bond proceeds to make loans to carry out ultimate
governmental purposes.
Additional Rules Applicable to Qualified Private Activity Bonds
Qualified private activity bonds are generally subject to the rules
described above and to additional limitations. Most significantly, with
some exceptions, the amount of tax-exempt qualified private activity
bonds that can be issued by each State (or its political subdivisions)
is subject to a unified annual State volume cap based on population.
Presently, the annual State volume cap is equal to the greater of $75
per resident or $225 million (increased for inflation for every year
after 2002). In general, the unified State volume cap on qualified
private activity bonds has provided a fair, flexible, and effective
constraint on the volume of tax-exempt private activity bonds.
The Code also places limitations on the types of projects and
activities that can be financed by qualified private activity bonds.
For example, the proceeds from qualified private activity bond cannot
be used to finance sky boxes, health clubs owned by an entity other
than a Section 501(c)(3) entity, gambling facilities, or liquor stores.
In addition, there are a number of more technical rules that apply to
qualified private activity bonds, including limits on the tax exemption
for bonds held by persons who are users of projects financed by the
bonds. There are also limits on the maturity date of the bonds, which
unlike governmental bonds is statutorily linked to the economic life of
the financed property. Furthermore, conduit borrowers who use the
proceeds of qualified private activity bonds are subject to penalties
if they use the bond proceeds in an inappropriate manner.
Application of the Operating Rules to Tax Credit Bonds
The general operating rules for tax-exempt bonds are established in
the Code and Treasury Department regulations. In theory, similar rules
should apply to tax credit bonds in order to ensure that the proceeds
from these bonds are being properly utilized, and to ensure that the
Federal subsidy is properly targeted. The three existing tax credit
bond programs, however, provide disparate statutory rules with
inconsistent incorporation of the general tax-exempt bond rules. For
example, the Code provides that the arbitrage rules and information
reporting requirements apply to certain tax credit bonds but not to
others. Similarly, remedial action rules are applied inconsistently to
tax credit bonds. In addition, due to the novelty and limited scope and
application of tax credit bonds, the rules otherwise applicable to tax-
exempt bonds cannot be applied without statutory authorization or
appropriate modification of existing regulations. Tax credit bonds also
raise new issues and challenges, including those highlighted below:
Eligible Uses. The projects and activities for which
qualified private activity bonds can be used are articulated in the
Code and defined in regulations that have been developed over time.
While the statutory provisions authorizing tax credit bonds similarly
describe eligible uses for the proceeds of these bonds, there is little
guidance on the specific types of projects or activities that qualify.
Moreover, because the permitted uses are often highly technical and
differ from the uses authorized for qualified private activity bonds,
entirely new sets of rules may need to be published.
Application to Pass-Through Entities. The complex nature
of tax credit bonds raises significant issues when those bonds are held
by pass-through entities or mutual funds. Accordingly, new rules need
to be developed to describe how the tax credit is both included in
income for members of a pass-though holder of a tax credit bond, and to
describe how the credit is ultimately used by the members or partners.
Credit Rate. For tax-exempt bonds, the markets set the
applicable interest rate. While there are some market inefficiencies
that arise from the limited size of some issuances, the market can
generally take them into consideration. In contrast, the Treasury
Department sets the rates for tax credit bonds. While the credit rate-
setting mechanism is designed to result in rates that permit the bonds
to be sold at par, that objective has not always been achieved in
practice and the Treasury Department may be less suited than the market
in determining the appropriate rate.
Maturities. For qualified private activity bonds, the
Code generally requires that the weighted average maturity of the bonds
be based on the economic lives of the financed projects or activities.
In contrast, the Treasury Department is charged with determining the
maturity date for all existing tax credit bonds at a level at which the
present value at issuance of the obligation to repay the principal of
the bonds is equal to 50% of the face amount of the bond. This rate-
setting methodology does not involve the typical consideration of the
economic life of the financed projects.
Volume Cap. The authorizing statutes for the three
existing types of tax credit bonds each limit the aggregate amount of
bonds that can be issued. Under the volume cap rules that apply to most
qualified private activity bonds, the IRS is only required to determine
the total amount of volume cap a State may allocate and States are
given the discretion to allocate their volume caps among permitted
types of projects in accordance with their specific needs. In contrast,
for some tax credit bonds the IRS is required to make allocations to
specific projects. This raises complex questions about how to allocate
bond authority when demand exceeds supply and how to determine the
technical merits of an application for bond authority. Although the
Treasury Department and IRS are responsible for answering these
questions, they often lack the non-tax expertise needed to do so and
must make judgment calls on which projects will be allocated bond
authority. Moreover, allocations of tax credits by the Federal
government outside of State volume caps weighs against the flexibility
and efficiency associated with allowing States to allocate limited
volume cap in accordance with State and local needs and priorities.
Special Purpose Tax-Preferred Bonds
In recent years, a number of new types of qualified private
activity bond programs have been created outside of the general volume
cap rules for specific targeted projects or activities. In addition,
three tax credit bond programs have been enacted for specific targeted
projects or activities that would not otherwise be covered by the
qualified private activity bond rules. A number of proposals for
additional types of private activity bonds and tax credit bonds have
been proposed, including recent proposals for high-speed rail
infrastructure bonds, transit bonds and Better America Bonds.
Special Purpose Private Activity Bonds
Recently enacted special purpose qualified private activity bonds
include those described below.
New York Liberty Zone Bond Provisions. The Job Creation and Worker
Assistance Act of 2002 provided tax incentives for the area of New York
City (the ``New York Liberty Zone'') damaged or affected by the
terrorist attack on September 11, 2001. New York Liberty Zone tax
incentives include two provisions relating to tax-exempt bonds: (1) $8
billion of tax-exempt private activity bonds that are excluded from the
general volume cap rules and that are allocated by the Governor of New
York and they Mayor of New York City in a prescribed manner; and (2) $9
billion of additional tax-exempt, advance refunding bonds. The dates
originally established for issuing bonds under the New York Liberty
Zone authority were extended by the Working Families Tax Relief Act of
2004. New York City has not used all of its allocated bond authority.
GO Zone Act Bond Provisions. The Gulf Opportunity Zone Act of 2005
(GO Zone Act) increased the otherwise applicable volume cap for
qualified private activity bonds issued by Louisiana, Mississippi and
Alabama. For each of these States, the GO Zone Act provided additional
volume cap through the year 2009. The GO Zone Act also provided that
interest paid on additional private activity bonds issued by under this
provision would be exempt from AMT. The additional volume cap authority
is estimated to be $7.9 billion, $4.8 billion, and $2.1 billion for
Louisiana, Mississippi, and Alabama, respectively. These States
collectively had over $1.8 billion in unused, carryover volume cap at
the end of 2004, raising some question as to whether, as happened with
the New York Liberty Zone bond authority, the additional volume cap
authority will be used.
Green Bonds. As part of the American Jobs Creation Act of 2004,
Congress authorized up to $2 billion of tax-exempt private activity
bonds to be issued by State or local governments for qualified green
building and sustainable design projects. ``Qualified green building
and sustainable design projects'' are defined to mean any project that
is designated by the Treasury Secretary, after consultation with the
Administrator of the Environmental Protection Agency, to be a qualified
green building and sustainable design project and that meets certain
other requirements. The Treasury Secretary is responsible for
allocating the dollar limit among qualified projects. Only four
qualified applicants submitted applications for green bond authority.
The IRS has made allocations among those qualified applicants. Because
the demand for an allocation of the limit was greater than the limit,
the allocation was made using a pro rata method.
Qualified Highway and Surface Freight Transfer Facility Bonds. The
Safe, Accountable, Flexible, Efficient Transportation Equity Act of
2005 authorizes the Secretary of Transportation to allocate a $15
billion national limitation to States and local governments to issue
bonds to finance surface transportation projects, international bridges
or tunnels or transfer of freight from truck to rail or rail to truck
facilities, if those projects receive Federal assistance. Bonds issued
pursuant to such allocation do not need to receive volume cap under the
normal bond rules. The statute generally requires proceeds to be spent
within 5 years from the date the bonds were issued.
Special Purpose Tax Credit Bonds
The three existing special purpose tax credit bond programs are
described below:
Qualified Zone Academy Bonds. Qualified Zone Academy Bonds (QZABs)
were first introduced as part of the Taxpayer Relief Act of 1997. State
and local governments can issue QZABs to fund the improvement of
certain eligible public schools. Eligible holders are banks, insurance
companies, and corporations actively engaged in the business of lending
money. QZABs are not interest-bearing obligations. Rather, a taxpayer
holding QZABs on an annual credit allowance date is entitled to receive
a Federal income tax credit. The credit rate for a QZAB is set on its
day of sale by reference to credit rates established by the Treasury
Department and is a rate that is intended to permit the issuance of the
QZABs without discount and without interest cost to the issuer. The
credit accrues annually and is includible in gross income (as if it
were an interest payment on a taxable bond) and can be claimed against
regular income tax liability. The maximum term of a QZAB issued during
any month is determined by reference to the adjusted applicable Federal
rate (AFR) published by the IRS for the month in which the bond is
issued. The arbitrage investment restrictions and information reporting
requirements that generally apply to tax-exempt bonds are not
applicable to QZABs.
Because issuers of QZABs are not currently required to file Form
8038 information returns, there is no reliable data on the volume of
QZABs that have been issued. Total QZAB issuances of $400 million per
year have been authorized since 1998, so the maximum aggregate volume
would be $3.2 billion. Although data is not generally available, it is
likely that a significant portion of this volume remains unused, since
many States did not use their full allocation in the early years of the
program, when the instruments were new to both issuers and investors.
Clean Renewable Energy Bonds. The Energy Tax Incentives Act of 2005
introduced a new tax credit bond for clean renewable energy projects.
This provision provides for up to $800 million in aggregate issuance of
clean renewable energy bonds (``CREBs'') through December 31, 2007.
CREBs are similar, but not identical, to QZABs in how they work. Like
QZABs, CREBs are not interest-bearing obligations. Rather, a taxpayer
holding CREBs on a quarterly credit allowance date (versus annual
credit allowance dates for QZABs) is entitled to a Federal income tax
credit. Unlike QZABs, there are no limits on who may hold these bonds.
The amount of the credit is determined by multiplying the bond's credit
rate by the face amount on the holder's bond. The credit rate on the
bonds is determined by the Treasury Department and is a rate that is
intended to permit issuance of CREBs without discount and interest cost
to the qualified issuer. The credit accrues quarterly and is includible
in gross income (as if it were an interest payment on the bond), and
can be claimed against regular income tax liability and alternative
minimum tax liability. Unlike QZABs, CREBs are subject to arbitrage
rules and information reporting requirements.
Gulf Opportunity Zone Tax Credit Bonds. The Gulf Opportunity Zone
Act of 2005 (GO Zone Act), authorized a third type of tax credit bond
referred to as ``GO Zone Tax Credit Bonds.'' These tax credit bonds can
be issued by Louisiana, Mississippi and Alabama in order to provide
assistance to communities unable to meet their debt service
requirements as a result of the Hurricane Katrina. Gulf Tax Credit
Bonds operate in much the same way as QZABs and CREBS, with the
economic equivalent of interest being delivered through a Federal
income tax credit that the holder can claim on its tax return. GO Zone
Tax Credit Bonds must be issued by December 31, 2006, and must mature
before January 1, 2008.
There have been other recent proposals for tax credit bonds as to
which the Administration has expressed strong reservations.
Tax Policy and Administrative Concerns Highlighted by Tax-Preferred
Bonds
Applying Generally Applicable Bond Rules to Special Purpose Bonds
In general, it would be preferable to subject any new or expanded
programs for tax-preferred bond financing to the existing regulatory
framework for tax-exempt bonds or to impose comparable general
restrictions and targeting restrictions. The general tax-exempt bond
provisions have well developed general restrictions. To take one
illustrative example, the tax-exempt bond provisions have extensive
arbitrage investment restrictions that limit the investment of tax-
exempt bond proceeds at yields above the bond yield and which require
that excess earnings be rebated to the Federal government, subject to
certain prompt spending and other exceptions. Similarly, the general
tax-exempt bond provisions have an information reporting requirement to
the IRS which assists Treasury and the IRS in analyzing use of tax-
exempt bonds. The tax credit bond program for QZABs, however, does not
impose arbitrage investment restrictions or information reporting
requirements, raising targeting and administrability concerns. In this
regard, various special other tax-exempt bond programs and tax credit
bond programs outside the general tax-exempt bond framework present
many administrability issues for Treasury and the IRS in assessing how
or to what extent to impose comparable rules by analogy.
Liquidity Concerns
The tax-exempt bond market generally caters to tax-sensitive
investors. Even in this large market, liquidity is low due to the small
size of individual issues and the limited attractiveness of the Federal
tax exemption. Low liquidity creates a number of problems that are
magnified in the context of special purpose bonds, all of which have
very small relative volume. Most notably, low liquidity requires the
issuer to offer a higher tax-exempt interest rate in order to ensure a
market for the bonds. This problem is magnified as the volume of tax-
exempt and tax credit bonds increases, forcing issuers to offer higher
rates in order to appeal to the same limited universe of holders. An
increased interest rate, in turn, increases the Federal subsidy for the
bonds.
Tax Credit Bond Considerations
For the three existing tax credit bond programs, the credit rate is
set at a rate equivalent to an AA corporate bond rate with the
intention that this pricing allow the bonds to be sold at par. In
practice, however, this has proven to be difficult. Investors in tax
credit bonds generally demand a discounted purchase price in comparison
to similar interest-bearing bonds in order to account for a number of
additional risks, including the possibility of not having sufficient
tax liability in the future to use the credit and liquidity concerns.
While more efficient from a broader economic perspective in
delivering a Federal subsidy, tax credit bonds have a number of
practical inefficiencies. The tax-exempt bond market is a longstanding,
established market with over $2 trillion in outstanding bond issues.
The market generally operates independently to set appropriate interest
rates. In addition, the general tax-exempt bond provisions under the
Code reflect a well developed set of rules and targeting restrictions
aimed at ensuring that the tax-exempt bonds carry out public purposes.
By comparison, the existing tax credit bond market is limited and
illiquid, and requires some inefficient, less market driven involvement
by the Treasury Department in setting the credit rates. These rates are
designed to allow zero interest tax credit bonds to price at par,
although this often does not happen in practice. In addition, tax
credit bonds introduce a number of new complexities, including issues
involving the timing of ownership relative to eligibility for using the
tax credits in the case of pass-through entities and other holders, the
inflexibility of tax credit bond maturity rules that are not tied to
project economic life considerations, and the inconsistent application
of general restrictions (e.g., arbitrage investment limitations) and
other restrictions comparable to those under the general tax-exempt
bond provisions.
In general, tax-exempt bonds and tax credit bonds have the same
fundamental purpose of providing a Federal subsidy as an incentive to
promote financing of public infrastructure and other public purposes
for State and local governments. That said, absent completely replacing
the tax-exempt bond subsidy with a broad-based tax credit bond subsidy
having carefully developed program parameters, the complexity and
awkwardness associated with parallel regulatory regimes for the large
tax-exempt bond program and the various limited tax credit bond
programs raises concerns.
Targeting of the Federal Subsidy
Statutes authorizing special purpose bonds typically carry specific
dollar amount authority, either as an exception to the normal volume
cap rules or as a targeted amount for tax credit bond issuances. With
bond financing, however, it is often difficult to predict the market
for the issuance, raising questions as to whether the authorization can
and will be utilized for its intended purpose. For example, the New
York Liberty Bond provision overestimated demand for private activity
bonds as a tool in rebuilding lower Manhattan after September 11th.
Accordingly, the full intended Federal subsidy was not delivered. New
York Liberty Bonds were seen as a model for delivering relief in the GO
Zone Act through authorizations of additional private activity bond
authority. The original New York Liberty Bond authority was carefully
targeted to a very small geographic area in lower Manhattan and, for
this reason, could be targeted to the economic character of that area.
Expanding the concept to such a large and economically diverse area as
the Gulf coast region damaged by Hurricane Katrina may raise additional
targeting concerns.
The experience with QZABs is also illustrative. While no statistics
are available (because QZABs are not subject to the normal information
reporting rules), we understand that many States do not use their
allocated QZAB tax credit bond authority while others would, if able,
use more. Thus, the incentive that was intended to be provided by QZABs
appears to have been both over-inclusive (for those States that do not
use the full amounts of their allocations) and under-inclusive (for
those States that could use more bond authority). In both scenarios,
targeting of the Federal subsidy has missed its mark.
Related to the problem of targeting the Federal subsidy is
competition between tax-preferred financing and other forms of
financing. This problem is exacerbated the further a bond-financed
project is from traditional governmental activities. When tax-preferred
bonds are used to finance necessary projects that would not be built
without a Federal incentive, the justification for the subsidy is
apparent. Where projects would have been built even without the
subsidy, or where the broader public justification for a project is
absent, the Federal incentive can result in a misallocation of capital.
Volume Cap Considerations
In general, the classification system for governmental bonds and
private activity bonds effectively targets the use of tax-exempt
qualified private activity bonds to specified exempt purposes with
extensive program requirements and effectively constrains those bonds
with the unified annual State volume cap. One structural weakness of
this general classification system is that, under the definition of a
private activity bond, a State or local government remains eligible to
use governmental bonds in circumstances involving substantial private
business use, provided that it secures the bonds predominantly from
governmental sources. While political constraints generally deter State
and local governments from pledging governmental sources of payment to
bonds used for private business use, this is nonetheless a structural
weakness of the definition of a private activity bond. A classic
example is financing for a stadium in which a professional sports team
uses more than 10% of the bond proceeds, but the State or local
government is willing to subsidize the project with generally
applicable governmental taxes and thus the stadium remains eligible for
governmental bond financing.
The unified annual State volume cap on qualified private activity
bonds generally has provided a fair, flexible, and effective constraint
on the volume of tax-exempt private activity bonds. The unified State
volume cap is fair in that it appropriately provides for allocation of
bond volume based on population, with some additional accommodation for
small States. In addition, the unified State volume cap is flexible in
that it accommodates diverse allocations of volume cap within States to
different kinds of eligible projects tailored to State and local needs.
In general, the unified State volume cap has been an effective way to
control private activity bond volume and Federal revenue costs. In this
regard, it is important to recall that, in the early 1980s before the
enactment of any volume caps, private activity bond volume grew at an
unchecked, accelerated pace. Between 1979 and 1985, private activity
bond volume grew from about $8.9 billion to $116.4 billion. While the
unified State volume cap has been somewhat less of a constraint in the
last several years since the volume cap was raised effective in 2002
(from the greater of $50 per resident or $150 million to the greater of
$75 per resident or $225 million, with annual inflation adjustments
thereafter), the unified State volume cap basically has been effective
and is preferable to alternatives.
While the case appropriately can be made for separate volume caps
for particular activities (e.g., New York Liberty Bonds) or for Federal
involvement in allocations (e.g., the new private qualified highway and
surface freight transfer facility bond program), as a general
structural and tax policy matter, the private activity bond volume caps
work best when imposed within the framework of the unified State volume
cap under section 146.
Allocations
Under the general private activity bond volume cap rules, each
State is required to allocate volume cap to the projects it deems most
worthy of a Federal subsidy. Some recent special purpose bonds diverge
from this historical State-based allocation system and require the IRS
or other Federal agencies to allocate new bond authority. For example,
the IRS has recently allocated the Green Bond national limit and the
Department of Transportation is responsible for allocating the volume
cap on the new exempt facility category for highway and surface freight
transfer facility projects
Requiring the IRS to make allocations raises a number of concerns.
Historically, allocations have been made by the States on the theory
that they are in a better position to understand local demands for
Federally-subsidized financing. In addition, because allocations have
historically been done by the States, there is no mechanism in place
for the IRS to perform bond allocations among proposed projects. More
significantly, with highly technical provisions such as Green Bonds and
CREBs, the IRS is not in the best position to determine how to allocate
a Federal subsidy to renewable energy projects or energy-efficient
projects. Thus, tax administrators are placed in the difficult position
of selecting between qualified applicants, without necessarily having
the technical knowledge needed to make informed allocation decisions.
While the Treasury Department and IRS do consult regularly with other
agencies having technical expertise, coordination can be time-consuming
and difficult. For example, tax administrators need to learn the
intricacies of energy policy while energy administrators need to learn
the nuances of tax-exempt bond law. It is questionable whether this
approach represents the most efficient use of limited government
resources.
Allocation problems also arise when a special purpose bond
provision is over or under-subscribed. If over-subscribed, the Treasury
Department and the IRS may have to pick among largely indistinguishable
qualified applicants or reduce all allocations pro-rata, which may have
consequences for the feasibility of a project. If under-subscribed,
unless the volume cap goes unused, the Treasury Department and the IRS
may need to reopen the application process for further submissions.
Given the limited time frame over which special purpose bonds are
generally authorized, additional rounds of applications are often
precluded.
Illustrative of other problems that can arise with allocations is
the American Jobs Creation Act provision authorizing Green Bonds as a
new category of qualified private activity bonds subject to an
exception to the normal volume cap rules. In providing an exception to
the volume cap, the statute also mandated that at least one qualified
applicant from a ``rural state'' be awarded an allocation of Green Bond
authority. The Treasury Department and IRS published a notice
specifically soliciting rural State applicants for Green Bonds, but no
applications were received.
Administrative Resource Considerations
The Treasury Department and the IRS are increasingly charged with
regulatory responsibility for writing rules for allocating and auditing
unique special purpose bond issuances. Because these special bond
programs are often created as independent programs outside the well-
developed structure of tax-exempt bonds rules (including established
volume cap rules), they present unique challenges in trying to ensure
that the myriad technical rules governing tax-preferred bonds correctly
apply. Uncertainty in the application of these rules can lead to delay
in implementing guidance (and, in turn, delay in issuing the bonds) and
can create uncertainty in the market, limiting the number of investors
and the effectiveness of the special purpose bond program.
Special purpose bond provisions require the Treasury Department and
the IRS to evaluate whether special rules are needed in order to
implement them. Because these provisions have such limited scope and
are highly complex, they require a disproportionate allocation of
administrative resources. Further, to help issuers comply with interest
arbitrage rules, the Treasury Department provides State and local
government issuers with the option to purchase non-marketable Treasury
securities known as State and Local Government Securities, or ``SLGS.''
Administration of this $200 billion program adds to the cost to the
Federal government in facilitating tax-exempt bond financing.
Examination Concerns
Special purpose bond provisions often contain unique rules defining
the projects or activities for which their proceeds can be used. For
example, with respect to CREBs, qualified projects are linked to the
technical eligibility requirements for the renewable energy credit.
Failure of a bond issuance to comply with eligibility requirements
results in disallowance of the credit to a third-party holder who had
nothing to do with operation of the bond-financed facility. The
technical nature of many special purpose bond provisions, combined with
the absence of historical rules and practices interpreting these
provisions, compounds an existing problem for tax-exempt bonds. For
tax-exempt bonds generally, the tax consequences of failure to comply
fall on the holder, who generally is without the information necessary
to determine whether the bonds comply.
Conclusion
The Administration recognizes the important role that tax-preferred
bond financing plays in providing a source of financing for critical
public infrastructure projects and other significant public purpose
activities. The Tax Reform Act of 1986 enacted a number of important
provisions such as the volume cap limitation that help to ensure that
the Federal subsidy being delivered is properly targeted and used for
its intended purpose. Over the past 20 years, a carefully structured
set of general statutory and regulatory rules have been developed under
the general tax-exempt bond provisions to further this goal. On
balance, tax-preferred bond financing works most effectively to target
uses to needed public infrastructure projects and other public purpose
activities when it is provided for within the existing general
framework of the tax-exempt bond rules, rather than within small
independent special regimes.
The cost to the Federal government of tax-preferred financing is
significant and is growing. Unlike direct appropriations, however, the
cost often goes unnoticed because it is not tracked annually through
the appropriations process. In addition to the cost to the Federal
government that results from providing a tax exemption or credit, there
are indirect costs, such as administrative burdens on issuers and the
IRS, imposed by the complex rules. These more indirect costs are
magnified in the context of special purpose tax-preferred financing.
When considering further expansions of tax-preferred bond
financing, it is necessary to ensure that the Federal subsidy is
properly targeted and used for its intended purposes, and that the
direct and indirect costs of the subsidy are carefully considered.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Chairman CAMP. Thank you, Mr. Solomon. I appreciate your
testimony very much. Dr. Marron, you may begin. You have 5
minutes.
STATEMENT OF DONALD B. MARRON, ACTING DIRECTOR, CONGRESSIONAL
BUDGET OFFICE
Dr. MARRON. Thank you, Mr. Chairman. It's a pleasure to be
here today to address yourself and the Committee and give to
give Congressional Budget Office's (CBO) perspective on tax-
preferred bond financing. I guess what I'll be presenting is
essentially the economist's view of these instruments of
financing projects. Just a couple of quick points. First, if
you look at traditional tax-exempt bonds, they clearly provide
a significant and important subsidy to projects undertaken at
the state and local level. Think of them in rough order of
magnitude as subsidizing somewhere in the neighborhood of 25
percent of the interest costs on the debt of those projects.
The challenge, from an economist's point of view on those,
in particular, is that the cost to the Federal Government and
thereby to the taxpayer is larger than the subsidy that is
received by the issuers. The reason that happens is the value
of the tax-exemption that's provided with the bonds differs
across different taxpayers based on the marginal tax rates that
they face. That in order to sell a complete issue of municipal
bonds, you need to price it in such a way and set the interest
rates in such a way that is attractive to people who don't just
have the highest margin of tax rates, but that have some of the
lower marginal tax rates. As a result, the interest rate that
is being set is one that's attractive, say, to someone who
might be in the 25 percent marginal tax rate bracket, but some
of those bonds will be purchased by people in higher marginal
tax rates, and they'll essentially get a windfall from it.
So, if you look at them in the aggregate, what you have is
that traditional tax-exempt bonds have a certain inefficiency
in them, that the amount of money that the Federal Government
and taxpayers are providing as a subsidy, some is going to a
windfall to people with higher marginal tax rates, and only a
portion is flowing through to the issuers and helping them
finance these projects.
In recent years, a separate and distinct way of providing
tax preferences has arisen, the development of tax credit
bonds. They work a little bit differently. As Eric hinted, they
have a much deeper subsidy per project.
Typically, the tax credit is structured in such a way that
it would be approximately 100 percent of the interest on the
bond, rather than, say, 25 percent. However, they're structured
in such a way that the tax credit is of the same value to
essentially all of the investors who might purchase them,
assuming they have enough taxable income to use the tax credit.
You do not have the effect that exists with traditional tax-
exempt debt.
So, on the one hand, tax credit bonds are more efficient,
in that they do a better job of each dollar of subsidy that the
Federal Government is providing, more of that dollar is getting
through to the issuer. On the other hand, they provide a much
deeper subsidy for the particular projects that qualify for it.
In my testimony, and some earlier reports that CBO issued,
we discussed one implication of that. The proposal has been
made by several folks, the one thing you might try to do is
design a hybrid tax credit bond in which the size of the tax
credit is more comparable to the interest rate subsidy that
traditional tax-exempt debt provides, but would be structured
as a tax credit in order to eliminate the inefficiency.
That's the financing side. Clearly, another significant
issue is the use to which this financing is put, what types of
projects are developed, what kinds of projects are financed in
this way.
As Eric hinted, one problem arises when the financing is
being used for projects that would have happened anyway. So,
projects that could have gone to private capital markets,
raised the money, and done what they needed to do. In that
case, the subsidy that's being provided in this way is a
windfall to the issuers of those bonds.
Secondly, there are some projects that wouldn't without
this support. For those projects, the issue arises about, are
you getting a misallocation of capital? Are you providing,
basically, additional financing to help the projects that could
not stand on their own in private markets. That could be bad,
if that's the end of the story, but that could be justified if
those projects provide other social benefits that warrant that
subsidy.
One of the real challenges that you and your colleagues
face--and that the state and local issuers face--is trying to
distinguish between those that have those additional social
benefits and are worthy, in essence, of this subsidy, and those
that are not. One particular issue to keep in mind, I think,
from Congresses' point of view is the extent to which these
various projects have benefits that would be national in scope
or national in importance, and not just a matter of providing
benefits to one local area, at the expense of other local
areas.
Wrapping up then, and this is something that Eric would
have more expertise on, a third level of concern that arises
with these financing mechanisms is the administration of them.
In particular, giving the need to try to have roles that target
the benefits on certain areas that provide social benefits.
That places a burden on the Treasury and the IRS, in order to
make sure that those targets, those desires, are implemented.
That's a challenge, just administratively, for folks to
execute. Also, under the current rules, there are limitations
in the degree to which they--the IRS in particular--receive
information that might be necessary to monitor compliance with
the various rules for these financing mechanisms.
So, there may be room for improvements along that front.
Then just to wrap up, this entire set of issues raises a larger
question of when you want to support projects through the Tax
Code, and when it might make sense to do them by something
through on the spending side. With that, I look forward to your
questions.
[The prepared statement of Dr. Marron follows:]
Statement of Donald Marron, Ph.D., Acting Director, Congressional
Budget Office
Mr. Chairman and Members of the Subcommittee, I am grateful for the
opportunity to appear before you to talk about the economic effects of
financing both public projects and private activities with tax-
preferred bonds.
In today's testimony, I will discuss the following four points:
The traditional form of tax-preferred financing--
exempting from federal taxation the interest income earned on state and
local bonds--is not a cost-effective means of transferring resources
from the federal government to state and local governments. Because of
the progressive structure of the federal income tax system, the revenue
loss that the federal government incurs from tax-exempt bonds exceeds
the debt-service savings that accrue to states and localities. More-
direct means of transferring resources--for instance, through
appropriations--could deliver equal or even greater amounts of aid to
the states at a reduced cost to the federal government.
Tax-credit bonds--a relatively new development in tax-
preferred financing--pay a larger share of state and local governments'
borrowing costs than do tax-exempt bonds. However, tax-credit bonds
could be structured to pay the same share as tax-exempt bonds at less
cost to the federal government.
The expansion of tax-preferred financing to private
activities raises additional concerns. State and local governments are
permitted, within limits, to use tax-exempt financing to support a
variety of activities, including aid to local businesses, the financing
of housing, and even the construction of sports arenas. Subsidizing
such endeavors, however, runs the risk of funding investments that
would be made anyway and of displacing more-productive investments with
less-productive investments, thereby reducing the value of overall
economic production. A key question is whether subsidized investments
provide social benefits to the nation as a whole or just to local
areas.
The tax-administration system is poorly equipped to
monitor compliance with the various targeting rules that the Congress
has adopted to achieve social objectives. That ability could be
enhanced if the Internal Revenue Service (IRS) could make greater use
of the information gathered by the issuers of state and local bonds.
However, a larger question would still remain: whether it is
appropriate or desirable to pursue certain societal objectives through
the tax code.
Tax-Exempt State and Local Public-Purpose Debt
Traditionally, the interest income earned on debt issued by state
and local governments has been exempt from federal income taxation.
That exemption lowers the interest rate that state and local
governments must pay on their debt and encourages investment in public
facilities. Purchasers of tax-exempt bonds are willing to accept a
lower rate of interest than they could receive on taxable bonds because
they are compensated for that difference with lower tax payments.
The exemption, which has existed since the inception of the income
tax in 1913, had its origins in the belief that such income was
constitutionally protected from federal taxation. Although the Supreme
Court rejected that argument in 1988 in South Carolina v. Baker, the
exemption has continued.\1\
---------------------------------------------------------------------------
\1\ 485 U.S. 505.
---------------------------------------------------------------------------
The federal government imposes some limits on the amount of such
debt that is issued. For example, a government could profit by
borrowing at low tax-exempt rates and then investing in taxable bonds.
Anti-arbitrage rules contained in the tax code regulate and limit such
opportunities. Additional limits are imposed by state and local
governments themselves and by the bond markets when questions of
creditworthiness result in higher borrowing rates.
In 2005, the outstanding stock of tax-exempt state and local
public-purpose debt equaled about $1.3 trillion. According to the Joint
Committee on Taxation (JCT), the revenue loss associated with the
exemption in fiscal year 2006 amounted to about $27 billion.
As alluded to previously, tax-exempt financing is not a cost-
effective mechanism for encouraging the formation of public capital.
Because of the progressive rate structure of the U.S. income tax
system, taxpayers with lower marginal tax rates receive lower tax
savings from the exemption than do taxpayers with higher marginal tax
rates. When an issuer must sell bonds to purchasers with lower marginal
tax rates, the issuer must set a higher interest rate on the bond issue
to compensate those purchasers for their lower tax benefits. As a
result, bond purchasers with higher marginal tax rates receive an
interest rate greater than they require to induce them to buy the
bonds. That windfall gain causes the federal government's revenue loss
to exceed the reduction in state and local borrowing costs, perhaps by
as much as 20 percent.\2\ That excess tax benefit is received by bond
purchasers with higher marginal tax rates.
---------------------------------------------------------------------------
\2\ The revenue loss and interest savings are determined,
respectively, by the average marginal tax rate (estimated to be about
30 percent) and the lowest marginal tax rate (about 25 percent) of bond
purchasers. If the taxable interest rate is 7 percent, for instance,
the federal government loses $1.20 of tax revenue for every $1.00
reduction in state and local borrowing costs.
---------------------------------------------------------------------------
In principle, it may be possible to deliver a higher amount of
fiscal aid to state and local governments at a lower cost to the
federal government if such aid is delivered as an outlay instead of as
a tax preference. Such a mechanism, the taxable bond option (TBO), in
which the federal government would pay a specified share of state and
local borrowing costs, was reported favorably by the House Committee on
Ways and Means in 1969 and 1976, and proposed by the Carter
Administration in 1978. State and local governments prefer the tax
exemption because it is available for any amount of borrowing they
choose to undertake, making it operate more like an entitlement. By
contrast, a TBO would be an outlay and subject to an annual
appropriation process, which would impose a limit on its availability.
Tax-Credit Bonds
Tax-credit bonds are a new tax-preferred bond option. They are
available as Qualified Zone Academy Bonds, adopted in 1997; Clean
Renewable Energy Bonds, adopted in 2005; and Gulf Tax Credit Bonds,
recently authorized as part of the Gulf Opportunity Zone Act of 2005. A
number of other applications have been proposed, almost all of which
are for activities that would have been eligible for tax-exempt
financing.
Current tax-credit bond programs provide more-generous subsidies
than do tax-exempt bonds. The purchaser of a tax-credit bond receives a
taxable tax credit set by the Treasury that yields tax savings
equivalent to the interest that would have been earned on a taxable
bond. For example, if the taxable-bond interest rate was 7 percent, the
bond purchaser would receive a taxable tax credit every year from the
Treasury Department equal to 7 percent of the face value of his or her
bond holdings. In essence, the federal government pays 100 percent of
the financing costs on the bond issue through the tax system. By
contrast, a tax-exempt bond pays only about 25 percent of borrowing
costs. Nonetheless, the tax-credit bond is more cost-effective than the
tax-exempt bond--every dollar of revenue loss is used to reduce state
and local borrowing costs.
A variation on the tax-credit bond could be used as a cost-
effective alternative to tax-exempt financing. Bond purchasers would
receive two payments: taxable interest income equal to their current
tax-exempt interest income, and a taxable federal tax credit equal in
value to the tax benefits that a tax-exempt bond would have provided to
the purchaser with the lowest marginal tax rate. Since the credit rate
would be the same for all bondholders regardless of their tax bracket,
there would be no windfall gain to taxpayers and the full revenue loss
to the federal government would be received as a subsidy by state and
local governments.\3\
---------------------------------------------------------------------------
\3\ The substitution of tax-credit bonds for tax-exempt bonds is
discussed more completely in Congressional Budget Office, Tax-Credit
Bonds and the Federal Cost of Financing Public Expenditures (July
2004).
---------------------------------------------------------------------------
Private-Purpose Tax-Exempt Bonds
Prior to 1968, the Congress imposed few restrictions on the type of
capital facilities that state and local governments could finance with
tax-exempt bonds. Over time, state and local officials began to use
such funding to finance more than just public capital investment. In
essence, they began to perform commercial banking functions, relending
borrowed funds to private entities for various purposes. As a result,
the share of bonds used to finance business investments and loans to
individuals grew. The Congress responded by imposing limits on the
issuance of bonds for those ``private activities''--restrictions that
have gradually been relaxed since 1986.
Currently, the outstanding stock of private-purpose tax-exempt debt
totals about $315 billion. According to the JCT, the revenue loss
associated with the exemption--including state and local funding for
housing (rental and owner-occupied), student loans, industrial
development, transportation, nonprofit institutions, energy, and waste
disposal--amounts to about $6 billion for fiscal year 2006. The
Congress set the ceiling on the annual volume of private-activity bonds
to rise gradually to a maximum of $75 per state resident in 2007. In
addition, the Gulf Opportunity Zone Act of 2005 provided for increases
in that ceiling for the areas affected by Hurricanes Katrina and Rita.
The expansion of tax-exempt financing to private activities raises
additional concerns besides excess lost revenue. Private-activity bonds
subsidize some investments that would be made without the subsidy--in
effect, transferring resources to private investors. Private-activity
bonds also distort the allocation of capital investment and thereby
reduce the nation's economic output. They do so by subsidizing
investments that would otherwise not be made, channeling scarce private
savings into investments that have a relatively low rate of return.
Companies will not undertake investment projects unless they expect
a return that is at least equal to the next best alternative use of
their funds. If they can obtain bond financing at a lower rate, the
profits (net of tax) that may accrue to the owners are increased. Thus,
if they have a choice between two investments, one that can be financed
with tax-exempt bonds and one that cannot, the one with tax-exempt
funding does not have to be as profitable or productive. Because the
tax-exempt subsidy does not increase the supply of funds in capital
markets, investment in the economy may flow from activities that yield
a higher private return to those that yield a lower return. As a
result, the value of total economic output may decline unless the tax-
subsidized activity has sufficient social or public value to compensate
for the lower private return. Given financial returns in today's
economy, a manufacturing firm that invests in a project made profitable
by substituting a small-issue industrial-development tax-exempt bond
for taxable bond financing might impose annual costs on the economy
that average more than $22 per $1,000 bond.\4\
---------------------------------------------------------------------------
\4\ The annual loss of tax revenue would be more than $19 per
$1,000 bond, and the reduction in national income might average
slightly more than $3.
---------------------------------------------------------------------------
Most social benefits can be measured qualitatively, at best, so
making judgments about whether such subsidies are worthwhile is
difficult. Restrictions on private-activity bonds were implemented as a
means to control the loss of federal revenue and national income from
private projects lacking social benefits.
When considering limiting the scope of private-activity bonds, it
is important to distinguish between local and national social returns.
For example, bonds issued for a nonprofit hospital may have a
presumption of providing social benefits to the community that can
arguably be said to extend to the nation, such as contributions to the
control of communicable disease and basic research in teaching
hospitals. But some activities that are financed with tax-exempt bonds
may lack such presumptions. That is particularly true when benefits are
strictly local rather than accruing to a broader population.
For example, small-issue industrial-development bonds are used to
finance investments by manufacturing companies. Since no presumption
exists that those companies are providing goods that are materially
different from other unsubsidized manufacturing competitors, nationwide
social benefits of a conventional nature are unlikely. State and local
officials' desire to subsidize those investments is based on their
belief that the investments are effective tools to stimulate local
economic development. However, the success of the bonds in achieving
that goal is not necessarily beneficial to federal taxpayers. The
subsidy might make the community where the subsidized firm is located
better off than it otherwise would have been, but other communities may
be made worse off. Federal taxpayers as a whole would not necessarily
gain. In effect, the social benefits may not be adequate to offset the
loss of national income and the reduction of the federal tax base,
unless federal taxpayers' objective is to reallocate investment within
the United States.
Trying to restrict the use of tax-exempt borrowing authority for
private activities may not prove successful in all instances, however.
Even with limits on or elimination of tax-exempt private-activity
financing, states and localities may find ways to continue funding
those activities through their regular public-purpose bond issues. For
example, the Congress prohibited the issuance of private-activity bonds
for professional sports stadiums in 1986. Yet some communities consider
the funding of those stadiums to be so important that they are willing
to finance them with general-obligation debt, pledging their taxing
power as security for the bonds. Because one community's successful
acquisition of a franchise comes at the expense of all remaining
communities without a franchise, the federal tax dollars provide no
benefits to federal taxpayers as a whole. Similarly, states and
localities can circumvent the limits on financing private activities by
undertaking the activities themselves in partnership with private
firms.
Administering Public Policy Through the Tax System
From an administrative perspective, much of the complexity in tax
law that relates to tax-preferred financing stems from the use of that
funding for private activities. The Congress limits the issuance of
tax-preferred bonds by restricting (``targeting'') private use to those
selected activities and users that are enumerated in sections 141 to
150 of the Internal Revenue Code. For example, the issuance of mortgage
revenue bonds and rental housing bonds requires that numerous
provisions relating to income eligibility and housing prices be
satisfied. Similarly, rules governing the issuance of small-issue
industrial-development bonds require that the use of such bonds be
restricted to companies with limited amounts of capital investment.
Virtually every type of private-activity bond has similarly detailed
targeting criteria.
Private legal counsel must certify that a bond issue complies with
federal tax law. After issuance, most monitoring of a bond issue's tax-
law compliance takes place at the state and local level. The extent of
monitoring among state agencies that issue mortgage revenue bonds,
hospital bonds, higher education bonds, small-issue industrial-
development bonds, and so on, varies widely. No requirement exists for
bond issuers or their support organizations to report on their
compliance with targeting rules, and state and local information is not
shared systematically with the IRS.
As a result, the extent to which compliance with federal
eligibility rules is maintained over the life of a bond is unknown. For
example, mobility and the changing income characteristics of tenants
may render a rental housing project ineligible for continued use of
multifamily rental housing bonds. Recipients of mortgages financed with
owner-occupied housing bonds may sell the house at a time that triggers
a requirement to repay the subsidy. And manufacturing companies that
use small-issue industrial-development bonds may be acquired by firms
whose capital-acquisition history makes them ineligible to use such
bonds. Many other requirements could be cited.
To determine whether compliance problems exist, the IRS has
established a program to sample bond issues for a particular private
activity. The program is not comprehensive, however. Compliance could
be enhanced if state and local organizations were required to monitor
compliance and report their findings to the IRS.
The discussion of administrative difficulties associated with
private-activity bonds raises a larger question, one that applies to
tax preferences in general. It is not always clear from the perspective
of public administration that the tax system is the best way to pursue
certain social objectives. For some objectives--such as those that are
means-tested--the tax system may lend itself to fulfilling social goals
because of the information it compiles on taxpayers' income status. But
in general, a bureaucratic apparatus designed to collect revenue may be
poorly suited to administer what are essentially spending programs.
There are two reasons for that. First, the administration of social
programs may serve to divert the attention of tax administration from
its principal purpose. Goals as divergent as collecting revenue and
regulating state and local support of certain private activities may be
difficult to pursue simultaneously.
Second, many government programs are subject to periodic review and
evaluation to determine how well they achieve their objectives and
whether their benefits exceed their costs. That effort requires
coordination within the executive branch to provide economic analysis
and performance evaluation and provides a basis for regular
Congressional oversight. Such efforts may be more effectively
undertaken in the context of similar programs and by agencies with
specific programmatic missions.
Chairman CAMP. Thank you very much, Dr. Marron, and I do
have a couple of questions. Mr. Solomon, there obviously has
been over recent years, an increase in the categories of bonds
that are allocated at the Federal level. Does the Treasury feel
that they have adequate guidance, both statutory and the
resources and expertise, to make the kinds of allocations that
are headed your way in legislation?
Mr. SOLOMON. It does preset a challenge to the Treasury
Department and the IRS to deal with the many new kinds of
bonds. In the recent years, there have been an increase in the
number of bonds. I have made a list. For example, in 2001,
Educational Facilities, 2002, Liberty Bonds, 2004, Green Bonds,
2005, Gulf Opportunity Zone Bonds. It does present a challenge
for the Treasury Department and the IRS in allocating its
resources to provide guidance--and to provide guidance quickly
-with respect to the new kinds of bonds, particularly when they
have different rules.
That is to say, there is a general framework with respect
to tax-exempt bonds, and there are general rules, for example,
the arbitrage and the allocation rules. In some of the new bond
issuances they have special rules. That is to say, they may be
outside the volume cap and they may have other exceptions. So,
it does present challenges to the Treasury Department and the
IRS to quickly provide guidance to get these programs up and
running. So, yes, it can present administrative problems. It
can present challenges, particularly where it involves
specialized areas that need technical expertise.
Chairman CAMP. Mr. Solomon, some of the recent bonds that
qualified, the Qualified Zone Academy Bonds (QZABs), Clean
Renewable Energy Bonds, and the Gulf Tax Credit Bonds, they're
not subject to the arbitrage or rebate requirements of the
Code. Does this inconsistent treatment impact the Treasury
Department's ability to administer the rules applicable to tax-
preferred bond financing?
Mr. SOLOMON. Having a proliferation of many different rules
presents challenges.
One of the values of having a single framework, a single
set of rules to deal with all the different kinds of bonds is
that it helps target the bonds, more effectively. So, not only
an administrative, but there's a policy question presented
there. When you have many different rules to different kinds of
bonds, it may affect targeting. Having one set of rules helps
the subsidy to be targeted more efficiently.
So, yes, having different arbitrage rules, for one set of
bonds than in others can present issues and it probably is
better to have a single set of rules, a single framework to
apply to all kinds of bonds.
Chairman CAMP. The bonds that I referred to earlier, there
are different credit rates for those bonds and The Treasury
Department sets those. Are there any concerns raised by that?
Mr. SOLOMON. Yes. You're referring to the tax-credit bond.
Chairman CAMP. Yes.
Mr. SOLOMON. With respect to tax credit bond, the Treasury
Department is directed to set the credit rate. In fact the
Treasury Department is directed to set the credit rate without
discount, which imposes a challenge for the Treasury
Department, because the Treasury Department has to pick a rate
where there will be no discount. The Treasury, in picking its
rate, does not take into account issuer-specific factors. For
example, credit quality, industry sectors, frequency of
pricing.
Therefore, it really is very difficult to set credit rates
in a way that there will end up being no discount. In fact,
it's our understanding for QZABs--which are a type of tax
credit bond--which has a statutory requirement that the rate be
set, that they sell without a discount. In that case we are
told that nevertheless, they are selling at a discount.
Chairman CAMP. Dr. Marron, obviously we've seen over the
last 20 years an expansion in the use of tax-preferred bond
financing, to increases in the amount of private activity bonds
that states can issue. Also the addition of activities that
qualify for preferred financing. Has that expansion had an
overall effect on the economy?
Dr. MARRON. As Eric and I indicated in our testimony, a
principal concern with providing tax-exemption to private
activities is concern about misallocation of capital. To the
extent that this type of financing becomes available to more
projects, you run a higher risk of projects occurring that,
again, wouldn't be able to stand on their own in a private
market, and can only survive because they get this assistance.
It is difficult to see that in the overall macroeconomic
data. We have an enormous economy even with a trillion plus or
minus in total tax-exempt debt, and 300 billion of these kinds
of bonds out there. It's hard to see an overall effect on our
enormous economy, but there's certainly the possibility that
there is some misallocation of capital, and that therefore
output is somewhat lower than it otherwise could be.
Chairman CAMP. Well, I was thinking particularly of the
public benefit to some of these bonds, and other Members have
referred to that. So, they may not have been decisions that
were made in the private sector. What about the overall public
benefit to some of these projects?
Dr. MARRON. Well, unfortunately, I have not seen anything
that would be a systematic look at the public benefits that
flow from these. I was talking to folks at CBO about this
earlier, and this falls in the category of areas that are
probably understudied in the community that does those sorts of
things. There isn't really a clean answer to whether the public
benefits that have been claimed are actually being provided.
Chairman CAMP. In your testimony, it may be suggested that
there may be areas where direct appropriation may be preferable
or more cost efficient. Do you think we can make modifications
that can improve the efficiency of tax-exempt bonds and tax
credit bonds?
Dr. MARRON. Certainly. As I hinted in my testimony--
certainly with traditional tax-exempt bonds--there is an issue
of this inefficiency that I mentioned. In essence, that the
amount of the money that the taxpayer and the Federal
Government are giving up in order to provide this support is
larger than the amount that's received by issuers. To the
extent that it's possible to move in the direction of making
the tax benefits look more like the tax credits, which don't
have that inefficiency, there may be an opportunity--
essentially you can have a win-win in the sense of delivering
the support in a more cost effective and less expensive manner.
Chairman CAMP. All right. Well, I want to thank you both
for your testimony. Thank you for your patience. I don't know
if there's anything you want to add at the end, to sum up, but
I appreciated your waiting through all that delay and the
series of votes that we had. Thank you for your excellent
testimony, both of you. You're welcome to make any closing
comments that you wish.
Dr. MARRON. I just want to go back to the question that you
asked Eric earlier, about to what extent it's important to have
a single set of rules or a finite set of rules. I think it's
important administratively, and as the economist, I'd also want
to point out I think that's very helpful for the capital
markets. To the extent that capital markets can begin to have a
sense that there's a large stock of bonds that operate under
simpler operating rules, it becomes easier to have a deeper
market. It's easier for the markets to understand and price
those.
Chairman CAMP. Okay. Thank you, Mr. Solomon, thank you, Dr.
Marron. That concludes panel number two. We'll now move to
panel number three. I will introduce to the Subcommittee Carla
Sledge, who is President of the Government Finance Officers'
Association, Walter St. Onge, III, President of the National
Association of Bond Lawyers, and Micah Green, President and
Chief Executive Officer of the Bond Market Association. We'll
start with Carla Sledge. Ms. Sledge, welcome. It's always good
to see a person from Michigan here. Everyone will have 5
minutes to summarize their testimony, and then we'll have some
questions afterward. You may begin, and your full statement
will be made part of the record, of course.
STATEMENT OF CARLA SLEDGE, PRESIDENT, GOVERNMENT FINANCE
OFFICERS ASSOCIATION AND CHIEF FINANCIAL OFFICER, WAYNE COUNTY,
MI
Ms. SLEDGE. Thank you and I bring greetings from Michigan.
Chairman Camp, my name is Carla Sledge, and I am the President
of Government Finance Office Association, (GFOA) and also the
Chief Financial Officer of Wayne County, Michigan.
The GFOA is a professional association of over 16,000 plus
state and local finance officers, and has served the public
finance profession since 1906. Wayne County is the 11th largest
county in the United States, with a budget of about 2.2
billion. I certainly appreciate the opportunity to speak before
you and this Subcommittee today on the important matter of
municipal bonds. This is a subject matter that is vital to
state and local governments across the United States, and this
statement reflects the policy statements of the GFOA as they
relate to the tax-exempt bond market.
Borrowing through access to the tax-exempt bond market is
the primary way in which states, cities, counties, towns, and
other governmental entities fund capital improvements to
provide utilities, housing, roads and bridges, airports, health
care, education, and other public services to the citizens.
Every one of us, at almost every turn, relies upon the
infrastructure provided by the financing of projects through
tax-exempt bonds. The ability to sell debt with interest exempt
from Federal income tax has been a significant benefit to state
and local governments, directly reducing the tax burden that
citizens would otherwise have to shoulder to finance essential
public services.
The importance of allowing state and local decisionmakers,
and the public at large, to evaluate what is needed within
their own communities cannot be emphasized enough. Decisions to
improve communities and build infrastructure should be done
from the ground up rather than the top, in order to best serve
the needs of citizens. Any attempt to curtail this essential
tenant of state and local government operations should be
abandoned.
Let me just give you some examples of infrastructure paid
for by bonds in my own backyard. In 1992, 33.6 million limited
tax general obligation bonds were issued for a medical examiner
facility that was built in 1996. This award winning state of
the art facility is approximately 48,000 square feet.
Over a billion dollars in bonds were sold in 1998 for the
Wayne County Metropolitan Airport, which serves the Greater
Detroit Area. This project included construction of a new
Midfield passenger terminal, renovation of an existing
terminal, and construction of a fourth parallel runway.
Finally, between 1994 and 2004, over 300 million in bonds
were issued for sewer improvement projects in our 32 downriver
communities. Of the 13 plus issues of debt in 2005, 85 percent
of those governments represent small and midsize communities.
Without efficient economic incentives to access the market,
governments would have to pay substantially more in interest
rate costs, which could limit the scope of the projects, or
deter projects from being done in the first place.
The need for thousands of governments to access the bond
market with even more hurdles than already in place would cause
grave disruption to the operations and the 2.7 trillion dollar
bond market.
Changes in inter-government relations over the past several
years has caused the financing needs of state and local
governments to increase not decrease. This is shown by the
reductions or elimination of various Federal assistance,
including grants and general revenue sharing, and an increase
in Federal mandates.
In 1999, the Congressional Budget Office issued a study
which concluded that total Federal spending on infrastructure
dropped from a little over 1 percent of Gross National Produce
in 1977, to about.57 percent in 1998.
Total Federal spending for infrastructure also declined as
a percentage of total Federal spending during the same period,
from 5.1 percent to 2.84 percent. Since most of the cost of
building and renovating the Nation's public infrastructure is,
and will be, borne by state and local governments, continued
use of tax-exempt financing will be vital if they are to meet
these needs in an efficient and economic matter.
We believe that to foster long-term growth in The United
States economy, Federal, state, and local governments must act
in concert rather than at odds with each other. The 1986 Tax
Reform Act and other tax legislation that has moved forward
over the past 20 years has imposed greater restrictions on
state and local governments who issue municipal bonds.
The consequences have caused less flexibility and greater
administrative and issuance cost to governments who need to
fulfill their responsibilities to provide necessary public
services and to meet Federal standards and mandates without
additional funds from the Federal Government.
In order to help a vast majority of state and local
governments, we have submitted tax simplification proposals
that include the need for additional refunding of debt, changes
in arbitrage rebate restrictions, repeal of the Alternative
Minimum Tax (AMT) on tax-exempt interest, eliminating
restrictions on bank interest deductions, and finally expanding
the ability for governments to enter into public-private
partnerships.
For almost 200 years, state and local governments have been
able to access the capital markets by issuing bonds to fund
their jurisdiction's public purpose infrastructure. The system
has worked well for all parties involved, especially state and
local governments.
The authority to issue tax-exempt bonds allow state and
local governments to determine the project needs of their
jurisdictions and pay for them through the issuance of bonds
without undue Federal Government interference. Without the
ability to access the low cost, tax-exempt, bond market,
communities across the United States would suffer, and greater
demands would be placed on the Federal Government to provide
additional direct funding to state and local governments. I
thank you once again for this opportunity to present this
testimony.
[The prepared statement of Ms. Sledge follows:]
Statement of Carla Sledge, President, Government Finance Officers
Association
Introduction
Chairman Camp and Ranking Member McNulty, my name is Carla Sledge
and I am the President of the Government Finance Officers Association
and the Chief Financial Officer of Wayne County, Michigan. I appreciate
the opportunity to speak before you and this Subcommittee today on the
important matter of municipal bonds. This is a subject matter that is
vital to state and local governments across the United States, and this
statement reflects the policy statements of the GFOA as they relate to
the tax-exempt bond market.
The Government Finance Officers Association (GFOA) is a
professional association of state and local finance officers, and we
are very proud to be celebrating our 100th year in 2006. Approximately
16,400 GFOA members are dedicated to the sound management of government
financial resources. Our members are state and local government finance
officials that have many responsibilities, including--the issuance of
tax-exempt bonds to finance public infrastructure; preparing operating
and capital budgets; managing public funds; and the financial
management of cities, counties, states and special districts including
school districts.
Purpose and Importance of Tax-Exempt Bonds
Tax-exempt bonds provide local and state governments access to the
capital markets and the ability to fund projects based on decisions
made at the level of government closest to citizens. The importance of
allowing state and local decision makers, and their constituents, to
make decisions about the infrastructure needs in their own communities
can not be emphasized enough. Decisions to improve communities and
build infrastructure should be done from the ground up, rather than the
top down in order to best serve the needs of citizens.
Borrowing through access to the tax-exempt bond market is the
primary way in which states, cities, counties, towns and other
governmental entities fund the capital improvements to provide
utilities, roads and bridges, airports, health care, education, housing
and other public services. Every one of us at almost every turn, relies
upon the infrastructure that is provided by the financing of projects
through tax-exempt bonds. The ability to sell debt with interest exempt
from federal income tax has been a significant benefit to state and
local governments, directly reducing the tax burden that citizens would
otherwise have to shoulder to finance essential public services.
State and local debt financing has been in existence since the
early 1800's, allowing states and then cities to finance infrastructure
that was and still is essential to communities and the economic well-
being of the United States. Two of the earliest projects funded by
bonds are the Erie Canal and creating rail systems in the states, which
promoted great economic prosperity for the United States.
Some specific examples of infrastructure paid by bonds today
include:
Wayne County, MI
In 1992, $33.6 million limited tax general obligation bonds were
issued for a medical examiner facility that was built in 1996. This
award winning, state of the art facility is approximately 48,000 square
feet.
Over $1 billion of bonds were issued in 1998 for the Wayne County
Metropolitan Airport, which serves the greater Detroit area. This
project included construction of a new midfield passenger terminal,
renovation of an existing terminal, and construction of a fourth
parallel runway.
Between 1994 and 2004, over $300 million of bonds were issued for
sewer improvement projects in 32 Downriver communities.
Hanover County, VA
The Kersey Creek Elementary School that will open in September was
built with $20 million of bonds that assisted the county in meeting the
federally mandated No Child Left Behind Act. Additionally, last year
voters approved with an overwhelming majority (79%) a $95 million bond
referendum that will be used for projects over the next five years
including: public safety/interoperability infrastructure so that
Hanover County fire and police officers can share the same frequency
with the City of Richmond and Henrico County; a new Mechanicsville
library; three new fire stations in Ashland, Farrington and Black
Creek; and a trades-based learning center.
Newington, CT
In 2005, $7.5 million in bonds were issued to expand the Newington
Police Station and over the past couple of years, $24 million of bonds
were issued to implement improvements to many Newington Public Schools.
Montgomery County, MD
Over $20 million on bonds were issued by Montgomery County that
will be used for a Community Recreation Center in North Potomac,
Maryland. This center will contain a gymnasium, exercise room, social
hall, senior/community lounge, conference room, and an extensive
outdoor recreation area. The community recreation center facility will
serve the needs of over 30,000 residents where currently no community
center exists.
To serve the needs of eastern and northern areas of Germantown, MD,
nearly $10 million of bonds have been issued to complete a new Class I
fire/rescue station.
For a Civic Building in Silver Spring, MD, the county has issued
$8.5 million of bonds to construct a building that will serve as a
focal point for County services and community events. This is part of a
multi-project effort by Montgomery County to support the redevelopment
of the Silver Spring Business District.
Changes in intergovernmental relations over the past several years
have caused the financing needs of state and local governments to
increase not decrease. This is shown by the reductions or elimination
of various federal assistance programs including grants and general
revenue sharing, and an increase in federal mandates. In 1999, the
Congressional Budget Office released a study which concluded that total
federal spending on infrastructure dropped from 1.06% of GNP in 1977
to.57% in 1998 (Trends in Infrastructure Spending, CBO, May, 1999).
Total federal spending for infrastructure also declined as a percentage
of total federal spending during the same period from 5.1% to 2.84%.
Since much of the cost of building and renovating the nation's public
infrastructure is and will be borne by state and local governments,
continued use of tax-exempt financing will be vital if they are to meet
these needs in an efficient and economic manner.
Of the 13,000-plus issuers of debt in 2005, 85% of the governments
represent small and mid-sized communities where the average amount of
debt issued was $9.5 million. Without efficient and economic incentives
to access the market, governments would have to pay substantially more
in interest rate costs, which could limit the scope of the projects, or
deter projects from being done in the first place. The need for
thousands of governments to access the bond market with additional
hurdles beyond those already in place, would cause grave disruption to
their operations and the $2.7 trillion bond market.
Need for Simplification
The Tax Reform Act of 1986 (``The Act'') affected the ability of
states and local governments to finance public capital investment with
tax-exempt municipal bonds. The Act had major consequences limiting the
purposes for which tax-exempt debt could be issued, the procedures to
be followed, and the ultimate value of such investments to investors.
Congressional actions resulted in the enactment of far-reaching
proposals that have imposed restrictions that burden state and local
governments in their traditional government financings. The consequence
has been less flexibility and greater administrative and issuance costs
to governments who need to fulfill their responsibilities to the public
and to meet federal standards and mandates without additional funds
from the federal government.
We believe that to foster long-term growth in the United States
economy, federal, state and local governments must act in concert--
rather than at odds with each other. The 1986 Act and other regulations
operate to prevent abuses in the bond market, but they have gone too
far, thus increasing bond issuance costs and forcing many governments
to hire more finance professionals in order to ensure compliance with
current laws. Thus, simplification measures are needed rather than
additional limitations on tax-exempt bonds. Simplification of the tax-
exempt bond provisions in the Internal Revenue Code would help increase
flexibility and reduce costs for state and local governments--and
taxpayers--and expand the positive characteristics of the tax-exempt
bond market for the future.
Specifically, we would encourage members of the Subcommittee, and
Congress at large to look at the following proposals when addressing
tax-exempt bond issues in future legislation:
Arbitrage Rebate
There is no greater burden to issuers of tax-exempt debt than
complying with federal arbitrage rebate rules. This is true both for
smaller, less frequent issuers of public debt who often do not have the
staff to comply with the rebate requirement and more regular issuers of
debt who find themselves bearing enormous administrative costs in
complying with the rebate rules as they apply to multiple bond issues.
Moreover, these compliance costs are disproportionate to the potential
arbitrage benefit involved.
Unused monies from proceeds of tax-exempt bonds are generally
invested until they are needed and, if invested at rates higher than
the borrower's rate of interest, they generate ``excess'' investment
income. The differential is known as ``arbitrage.'' Under the arbitrage
rebate requirement that has been in place since 1986, arbitrage must be
rebated to the federal government. While some relief was provided in
1989, arbitrage compliance remains one of the largest administrative
and costly burdens that governments face. Additionally current law,
last updated in 1989, dictates various spending requirements for bonds,
including the need for 100% of available bond proceeds to be spent in a
24 month period for construction bonds. This is a short time frame for
many projects to be completed, and many governments run into problems
in order to comply with this stringent regulation.
A special hardship is for small issuers of debt. Eight-five percent
of debt issuers in 2005 contributed to only 15% of the entire volume of
bonds sold. Since 1986, the small issuer exception has been in place
that allows governments who issue less than $5 million of debt annually
to not adhere to arbitrage compliance. The $5 million limit set in 1986
is equivalent to $9,046.00 today (according to the Bureau of Labor
Statistics). Although the amount has doubled in twenty years, there has
been no willingness to increase the small issuer exception amount, nor
index it to inflation. Increasing the amount will help a vast majority
of small issuers, without affecting 85% of the bond market volume.
Two areas in particular require remedy. First, the amount of annual
debt exempted from arbitrage rebate restrictions should be raised from
$5 million to $25 million. This will help a vast majority of issuers
from adhering to needless and costly requirements. Second, the spend-
down exception should be extended from two years to three.
Advance Refunding
In order to provide state and local governments with the tools and
flexibility to face changing circumstances, they need the ability to
refund their debt and reduce borrowing costs so that more financial
resources are available. Issuers currently have only one opportunity to
take advantage of favorable market conditions and achieve lower
borrowing costs, before the original bonds mature or are callable.
Somewhat similar to homeowners being able to refinance their mortgage
to take advantage of lower mortgage payments, the same opportunities
should be available to state and local governmental entities.
Following the 9/11 attacks as well as the Katrina aftermath,
Congress wisely allowed for outstanding bonds in these areas to take
advantage of an additional advance refunding. This helped governments
lower their debt service payments so that they would have funds
available for other necessities. In the case of the Gulf Coast region,
this helped bonds to be restructured so that governments could extend
debt service payments in order to keep their credit intact while not
suffering from an inability to pay their obligations.
We ask that Congress provide a second advance refunding for all
current and future tax-exempt bonds issues.
Bank Deductibility
Prior to the 1986 Act, commercial banks were the largest investor
in tax-exempt bonds. Pre-1986 law permitted banks to deduct all or
portions of the interest costs they incurred to invest in municipal
bonds. The 1986 Act placed a severe limit on the amount banks could
deduct--80% of the costs of purchasing and carrying bonds of issuers
that do not issue more than $10 million of bonds annually. The result
has taken away a major purchasing sector of tax-exempt bonds, which in
effect hurts many governments.
The bank deductibility limitation harms many small governments that
have regular capital needs higher than $10 million. Governments often
defer needed projects until a subsequent calendar year in order to
comply with the $10 million limit in any one-year. Additionally, in the
face of rising compliance costs that did not exist when the $10 million
limit was set, bank eligible financing would be an attractive and
vastly more efficient vehicle for these smaller entities to finance
their projects, but unfortunately current law deters them from doing
so. Additionally, indexed to inflation, the $10 million amount set in
1986 equals nearly $18 million today.
We strongly recommend that the bank deductibility limit be raised
from $10 million to $25 million and indexed for inflation thereafter.
Alternative Minimum Tax
As the AMT is capturing more individuals and businesses than ever
imagined at its conception over 30 years ago, there have been
unintended consequence placed on the tax-exempt bond market. Some bonds
have AMT exposure, and thus the market demands a higher yield for these
bonds.
Due to changes in the 1986 Act, many bonds for public purposes must
be issued as private activity bonds. Governmentally owned facilities,
such as public airports, solid waste facilities, ports, and water and
sewer facilities, are defined as ``private activity bonds'' due to
operation or other participation by private entities.
An example of the hardship that is placed on the
mischaracterization of these governmental bonds is most notably airport
bonds. In 1998, the Albany County Airport Authority, NY issued
$30,695,000 of Airport Revenue Bonds to finance two capital projects.
Due to the complicated tax laws, two separate bond issues, one
governmental and one AMT had to be issued, causing the Authority to pay
additional bond issuance costs due to the higher yield for the AMT
bonds.
We ask that Congress repeal the Alternative Minimum Tax on tax-
exempt bonds. Issuers of these bonds would benefit from lower borrowing
costs and this would help restore demand from those individuals and
corporations that are subject to the AMT. We also recommend that all
bonds issued for governmental purpose be classified as governmental
bonds.
Expansion of Public-Private Partnerships
In many aspects, Congress and various Administrations have
encouraged greater public-private partnerships. Many vital economic
development projects require significant public commitment combined
with private investment. The ability to fund the public share of costs
with tax-exempt bonds allows these projects to proceed. Current tax
laws limit the amount of private use of a governmental facility to ten
percent. This inhibits the financing of facilities where private use
could materially assist delivery of public services.
For example, publicly funded parking structures integrated with
private retail establishments ensure safe and easy access to
facilities. Such projects are difficult to fund with tax-exempt bonds,
however, because of restrictive private activity bond rules.
We recommend that the threshold test for acceptable private
business use be increased and that more flexible allocation rules be
developed to facilitate private participation in public projects.
Purchasers of Tax-Exempt Bonds
As noted above, after the 1986 Act, banks went from being the
largest group of tax-exempt bond purchasers to one of the smallest.
Similar rules are in place for corporate and property & casualty
insurers who need and want to purchase tax-exempt bonds for a variety
of reasons, most notably their secure standing as a financial product.
Various proposals have been brought forward over the past twenty
years that would place additional requirements on corporations and
property & casualty insurers who are purchasers of tax-exempt debt.
Such proposals would not harm these private sector entities themselves,
but would directly hurt state and local governments if these entities
stopped purchasing tax-exempt bonds. As an example, in 2005, property &
casualty insurers held 16% of outstanding tax-exempt debt. If these
purchasers were to leave the market, there would be a significant
impact on state and local governments who would have to pay a great
deal more in interest costs, as the purchaser pool becomes more
limited.
Do not decrease, but instead increase the incentives for
corporations, insurers, and the banking community to purchase tax-
exempt bonds.
Other Congressional Action that Impacts the Tax-Exempt Bond Market
Congress also acts in indirect ways that influence the tax-exempt
bond market. For many bonds, governments must use tax revenues to make
payments to bondholders. When those revenue streams are in jeopardy,
governments face greater pressure to meet their current and future
obligations. Oftentimes when Congress makes decisions to limit state
and local governments' revenue collecting capabilities--through
legislation that bans taxation of internet access; disallows state and
local taxation of remote sales; places restrictions on the taxation of
communications services and franchise fees; and restricts the
deductibility of state and local income, sales and property taxes--it
adversely impacts the financial management of state and local
governments.
Conclusion
As Congress looks at past and proposed municipal bond proposals we
ask that Members recognize the continued need for tax-exempt bonds as a
way to provide essential services to our citizens. World-class
infrastructure has been and continues to be provided because of the
tax-exempt bond market. Municipal bonds serve as a good illustration of
a true partnership between the levels of government, as they are used
to pay for the capital projects that serve as the delivery mechanism
for federal priorities--including the No Child Left Behind Act and
greater public safety needs following 9/11.
In 1989, the final report of the Anthony Commission on Public
Finance--Preserving the Federal-State-Local Partnership: The Role of
Tax-Exempt Financing, provided suggested changes that were apparent
after the 1986 Tax Reform Act went into effect. Many of these
conclusions remain valid today and should be reviewed when deliberating
on tax-exempt bond issues.
A review of the tax simplification needs made in this testimony as
well as in the Anthony Commission Report may best be summarized as
follows:
1. Change arbitrage rebate restrictions;
2. Eliminate restrictions on bank interest deductions;
3. Repeal the AMT on tax-exempt interest;
4. Create new rules distinguishing between governmental and
private-activity bonds and reclassify truly governmental purpose bonds
as such; and
5. Allow for an additional refunding of tax-exempt debt.
For almost 200 years, states and local governments have been able
to access the capital markets by issuing bonds to fund their
jurisdiction's public purpose infrastructure. This system has worked
well for all parties involved, especially state and local governments.
The authority to issue tax-exempt bonds at the state and local level
allow local and state governments to determine the project needs of
their jurisdiction and pay for them through the issuance of bonds,
absent federal government interference. Without the ability to access
the low cost, tax-exempt bond market, communities across the United
States would suffer, and greater demands would be placed on the federal
government to provide additional direct funding to local and state
governments.
Thank you very much for the opportunity to provide this testimony.
Chairman CAMP. Thank you very much for your testimony. Mr.
St. Onge, you have 5 minutes.
STATEMENT OF WALTER J. ST. ONGE III, PRESIDENT, THE NATIONAL
ASSOCIATION OF BOND LAWYERS
Mr. ST. ONGE. Thank you, Chairman Camp, for inviting me to
speak to you today. I am Walter St. Onge, a partner in the law
firm Edwards, Angel, Palmer, and Dodge, of Boston
Massachusetts. I am here today as President of the National
Association of Bond Lawyers, or NABL.
The NABL is a professional association with more than 3,000
who specialize in the municipal bond area. The NABL's original
statement of purpose provided in part that it shall promote the
public good by educating its members and others in the law
relating to state and municipal obligations, improving the
state of the art in this field, and providing advice and
comments with respect to matters affecting state and municipal
obligations.
The NABL Board of Directors reaffirmed this commitment when
it adopted a vision statement in 2005, stating that NABL exists
to promote the integrity of the municipal market by advancing
the understanding of, and compliance with, the law affecting
public finance.
The municipal bond market is an important part of The U.S.
economy, providing financing for governmental functions and for
the infrastructure essential to economic growth and job
creation and state and local self-government and fiscal
autonomy. This public financing mechanism underpins our unique
Federal system of state and local self-government.
Each year, thousands of issuers and borrowers, ranging from
the largest state governments to the smaller school or fire
district, decide what their capital needs are and how to best
meet those needs.
The municipal bond market enjoys high levels of consumer
confidence, based on its long history of economic strength, low
default rates, and the integrity of the market's participants.
The role of bond counsel is a cornerstone of the efficient
operation of the market. The NABL's educational efforts promote
the continued high standards of practice of its members. These
efforts include annual seminars and periodic teleconferences on
a full range of topics, including active participation by
government officials, particularly from the Treasury, the IRS,
and the Securities and Exchange Commission. Other NABL efforts
include comment projects and guidance requests.
In 2002, for example, NABL submitted a lengthy report to
the Treasury Department regarding tax simplification
recommendations. A shorter version of this report was submitted
to your Subcommittee in 2004.
Another recent project was a letter sent last September to
the Treasury Department regarding the role municipal bonds in
the historic rebuilding efforts required in the wake of
Hurricane Katrina. This letter identified potential
administrative and legislative actions that could be taken to
help alleviate the dramatic effects of Katrina in the affected
region.
The function of bond counsel originated in the 19th century
in response to growing investor concern regarding the validity
of debt instruments issued by state and local governments.
Today, the essential components of bond opinions address not
only validity, but also the Federal tax treatment of interest
on the bonds.
In most cases, bond counsel renders an unqualified opinion,
which essentially means that the bond counsel is firmly
convinced that the highest court of the relevant jurisdiction
would agree with those legal conclusions. The unqualified bond
opinion has become a required feature of most municipal bond
issues.
While the opinion is not a guarantee, the high standard
under which it is issued essentially allows investors to factor
out any special risks regarding validity or tax-exemption in
pricing the bonds.
The wide range of permitted purposes and issuers of
municipal debt also insures a wide range of complexity in
transactions. However, many aspects of the tax laws applicable
to tax-exempt debt generally apply to all transactions, or
reflect longstanding requirements. This allows bond counsel and
other market participants to analyze and structure issues
efficiently, and permits more effective administration and
oversight of transactions.
New forms of tax favored financing commonly result in
increased transaction costs, at least in the short term, as
bond counsel and other participants must familiarize themselves
with the new product, analyze new questions, and educate
investors. Existing tax laws have allowed the municipal market
to grow and prosper. While the 1986 Tax Reform Act imposed
significant new restrictions on the market, it nonetheless
preserved access to capital at less expensive rates.
The NABL believes that any tax reform proposal should
promote a more efficient municipal bond market, but should also
preserve the ability of local governmental units to make
independent decisions regarding the most effective way to serve
the needs of their citizens and to promote their economic
development.
The municipal market remains a vital component in the
Federal-state relationship by providing infrastructure to the
Nation through local decisionmaking and access to the capital
markets.
The NABL is dedicated to insuring that the market remains
confident in the value of the opinions that we render. We
intend to continue to promote the municipal bond market to
insure that it remains a safe, liquid, and transparent market
for all of its participants. Thank you very much.
[The prepared statement of Mr. St. Onge follows:]
Statement of Walter St. Onge, III, President, National Association of
Bond Lawyers
Good morning. I am Walter St. Onge, a partner in the law firm of
Edwards Angell Palmer & Dodge of Boston, Massachusetts. I am here today
as President of the National Association of Bond Lawyers.
I would like to thank Chairman Camp and Ranking Member McNulty for
inviting me to speak to you today on behalf of our Association.
The National Association of Bond Lawyers (NABL) is a professional
association with more than 3,000 members who specialize in the
municipal bond area.
The original statement of purpose of the Association provided, in
part, that: ``the purpose of the Association shall be to promote the
public good by:
Educating its members and others in the law relating to
state and municipal obligations,
Improving the state of the art in this field, and
Providing advice and comments with respect to
legislation, regulations, rulings and other action, or proposals,
affecting state and municipal obligations.''
The NABL Board of Directors reaffirmed NABL's commitment to
improving standards in the municipal bond market when it adopted a
vision statement in 2005 to the effect that NABL exists to promote the
integrity of the municipal market by advancing the understanding of and
compliance with the law affecting public finance.
The municipal bond market is an important element of the United
States economy, providing financing for general governmental functions
and for the infrastructure that is essential to economic growth and job
creation in a manner that promotes state and local self-government and
fiscal autonomy. The United States is the only nation that permits
autonomous state and local governments direct access to the capital
markets to finance state and local infrastructure.
This public financing mechanism underpins our federal system of
state and local self-government. Year in and year out, thousands of
municipal bond issuers and borrowers across this country, ranging from
the largest state governments down to the smallest school or fire or
sewer district, decide what their capital needs are and how to best
meet those needs. The cumulative effect of those decisions is reflected
in the annual issuance of municipal bonds, including over $400 billion
in 2005. The economic impact of these expenditures is obvious and
significant. The municipal bond market benefits all of its disparate
borrowers by providing them equal access to funding on favorable terms.
The municipal bond market enjoys high levels of investor confidence
based on its long history of economic strength, extraordinarily low
default rates and the integrity of the market's issuers and
professionals. The role of bond counsel is a cornerstone of the
efficient operation of the market. The integrity and professionalism of
bond lawyers are key to maintaining the high level of investor
confidence in the municipal bond market.
NABL educational efforts promote the continued high standards of
practice of its members and assist practitioners and regulators in
advancing the state of the law. These efforts include annual seminars
and periodic teleconferences on a full range of topics. These events
include meaningful participation by federal government officials and
other market participants.
Other significant NABL efforts include comment projects on
regulatory and legislative matters and guidance requests on particular
topics pertaining to the municipal bond area. In 2002, for example,
NABL submitted a lengthy report to the Department of the Treasury
regarding tax simplification recommendations for tax-exempt bonds. In
2005, NABL resubmitted these recommendations to the President's
Advisory Panel on Federal Tax Reform and to the Department of the
Treasury for review and consideration for inclusion in any tax reform
proposals.
Another notable project was a letter submitted on September 7,
2005, to the Department of the Treasury regarding the role of municipal
bonds in the historic rebuilding efforts required in the wake of
Hurricane Katrina. This letter identified potential administrative and
legislative actions that could be taken to help alleviate the dramatic
effects of Hurricane Katrina in the affected region. We were mindful
that the immediate task was emergency assistance for the citizens of
that area, but we also recognized the disastrous effects on the state
and local governments and their ability to provide not only immediate
services, but also longer-term reconstruction activity and normal
governmental services. Some of our suggestions were subsequently
incorporated in action taken by the administration and in the Gulf
Opportunity Zone legislation enacted by Congress.
The function of bond counsel originated in the 19th century in
response to growing investor concern regarding the validity of debt
instruments issued by state and local governments. Adverse court
decisions led underwriters and bond purchasers to seek legal opinions
to provide assurance as to the validity of the debt.
By the early 1900s, the practice of engaging bond counsel to
provide an expert and objective legal opinion with respect to the
validity of bonds was widespread. Today, the essential components of
bond opinions address the validity of the bonds and the tax treatment
of interest on the bonds, particularly, the federal tax aspects.
The bond opinion facilitates the sale of the bonds and thereby
assists the issuer in carrying out the public purpose for which the
bonds are issued.
In most cases, bond counsel renders an ``unqualified opinion''
which essentially means that bond counsel is ``firmly convinced that
the highest court of the relevant jurisdiction, acting reasonably and
properly briefed on the issue, would reach the legal conclusions stated
in the opinion.
The ``unqualified'' bond opinion has become a well-accepted, and in
most cases, a required feature of municipal bond issues. While the
opinion is not a guarantee, the high standard under which it is issued
essentially allows investors to factor out any special risks regarding
validity and tax exemption in pricing the bonds. The favorable bond
opinion, delivered by recognized bond counsel, promotes the efficiency
of the municipal bond market (since bond purchasers rarely feel the
need to retain separate, additional counsel) and contributes
significantly to the overall successful workings of the market.
To date, public financing has resulted in over $2 trillion of
valuable state and local infrastructure and other capital projects.
Without the municipal bond market, state and local governments would
have to look to the federal government to bear a greater share of the
infrastructure costs or forego the infrastructure entirely if federal
financing were not available.
The municipal bond market serves the needs of state and local
governments, educational institutions, charitable organizations and
certain qualified private entities by providing efficient access to
capital, and addresses the needs of the bond purchasers by providing
efficient access to liquid investments. The types of debt issued
include traditional general obligation and revenue bonds, so-called
private activity bonds for certain purposes and more recently, tax
credit bonds for particular, special programs.
The wide range of permitted purposes and issuers of municipal debt
also ensures a wide range of complexity in the structure of
transactions. However, many aspects of the tax laws applicable to tax-
exempt debt generally apply to all transactions or reflect long-
standing requirements. This allows bond counsel and other market
participants to analyze and structure issues efficiently and permits
more effective administration and oversight of transactions. It also
enhances the market's liquidity by allowing investors to effectively
take tax risk out of their pricing decisions--assuming, of course, that
an ``unqualified'' bond opinion is being offered as part of the
transaction. New forms of tax-favored financing commonly result in
increased transaction costs, at least in the short term, as bond
counsel and other market participants must familiarize themselves with
the nuances of the new product and analyze new legal and financial
issues that may arise, as well as educate investors about the new types
of projects.
Existing tax laws have allowed the municipal bond market to grow
and prosper. While the 1986 Tax Reform Act imposed significant new
restrictions on the municipal bond market, it nonetheless preserved the
fundamental access to capital at less expensive rates. NABL believes
that any tax reform proposal should promote a more efficient municipal
bond market, but should also preserve the ability of local governmental
units to make independent decisions regarding the most effective way to
serve the needs of their citizens and to promote their growth and
economic development.
Simplifying and improving the efficiency of the municipal bond
market is critical to enable state and local governments to perform
their role in providing cost-effective financing for ever-expanding
public infrastructure needs and other public purposes.
Last fall, the President's Advisory Panel on Federal Tax Reform
issued its final report on a wide range of possible tax reforms,
including provisions that would adversely affect the municipal bond
market. If enacted, the proposals would significantly reduce demand for
tax-exempt bonds by corporations and thus dramatically increase
interest costs for state and local governments. The proposals would
also adversely affect individual investors who hold the remainder of
the over $2 trillion of outstanding tax-exempt bonds, as the value of
their bonds will decline in response to a decline in their
attractiveness to business.
The municipal bond market has been and remains a vital component in
the federal-state relationship by providing infrastructure to the
nation through local decision-making and access to the capital markets.
Our members have served over the years as advisors to various market
participants to develop successful financing programs that meet the
needs of the state and local governments and their constituents and,
where appropriate, incorporate innovative financing techniques to
assure the most effective capital program for each issuer across the
country.
NABL is dedicated to assuring that the market remains confident in
the value of the opinions we render. We intend to continue to promote
the municipal bond
market to ensure that it remains a safe, liquid and transparent market
for all of its participants, issuers and investors alike.
Thank you.
Chairman CAMP. Thank you very much, Mr. St. Onge. Mr.
Green, you have 5 minutes and your full statement will be part
of the record, as well.
STATEMENT OF MICAH S. GREEN, PRESIDENT AND CEO, THE BOND MARKET
ASSOCIATION
Mr. GREEN. Thank you, Chairman Camp. It's a great pleasure
to testify before you today on tax-preferred bonds. The Bond
Market Association represents underwriters and dealers of all
bonds and related products, and most particularly the over two
trillion dollar outstanding municipal bond market. We have a
longstanding tradition of working very closely with this
Committee on Ways and Means, and have appreciated your
leadership over the years on these issues.
Our members firmly believe in the value and efficiency of
the tax-exemption for municipal bonds which illustrates inter-
governmental relations at its very best.
Since association members underwrite and trade both taxable
and tax-exempt securities, we could theoretically be
indifferent toward the tax treatment of state and local
government bonds. However, in that regard, our comments here
today reflect our interest in seeing the most efficient
municipal bond market possible, that work best for taxpayers,
state and local governments and investors, and the Federal
Government in meeting national interests.
In sum, our comments are these. The Federal tax-exemption
for municipal bonds is longstanding and has been affirmed by
the courts and maintained by Congress for the past nine
decades. It is complimented by a prohibition on the taxation
Federal Government bonds at the state level.
The ability of local voters and their elected officials to
make decisions on local infrastructure finance eliminates a
layer of bureaucracy that is associated with Federal
appropriations that can lead to wasteful misallocation of
resources.
The capital markets, because of their capacity to finance
infrastructure projects, and the inherent market discipline
that provides, that they enforce on borrowers, is the best
funding source for the capital needs of the state and local
governments. The tax-exemption links thousands of state and
local governments to the capital markets that would otherwise
have no access.
In many ways, the municipal bond market reflects the simple
genius of our Founding Fathers. It is essentially a federalist
system of public finance. It's designed to meet local needs by
making municipal bonds attractive to investors at below market
rates. It's those below market rates that reduce the cost of
borrowing for states and localities.
The decisions these governments make to issue bonds to
investors brings with it a promise to pay timely interest and
principle back. The default rate, as a previous witness said,
in the municipal bond market is close to zero. Since the tax-
exemption was explicitly adopted as part of the first Internal
Revenue Code 1918, Congress has monitored it closely. At
various times, lawmakers have proposed to revoke the tax-
exemption or replace it altogether.
These efforts have always failed, largely out of a
recognition that the municipal bond market constitutes the most
efficient means available for state and local governments to
finance public infrastructure. The market today, as a result,
is a well functioning system that efficiently provides Federal
assistance for governmental and other public purposes. Congress
has recognized the financing needs of state and local
governments are unlike those of corporations and other private
borrowers.
Consider that there are more than 50,000 separate municipal
bond issuers that have over one million separate bond issues
outstanding, most in amounts of less than one million dollars.
For these very small issuers, the municipal market is the only
realistic source of low-source capital. Banks would be
unwilling to lend under the same terms and the same small size
and unique characteristics of each municipal bond. It would
prevent their broad acceptance by investors in taxable
securities.
No other system can offer the low cost financing that tax-
exemption provides, combined with the local control over
financing decisions. Municipal issuers would face significantly
higher borrowing costs if the tax-exemption were eliminated.
Direct appropriations by Congress, invariably at a level of
bureaucracy that would distort the allocation of that Federal
assistance.
If such appropriations were unlimited and came with no
strings attached and no bureaucratic overlay, it would simplify
the issue of infrastructure finance.
This is obviously not possible. The tax-exempt municipal
bond market creates the appropriate partnership needed to meet
National needs at the local level.
Congress turned to such partners in the wake of the 9/11
terrorist attacks, and more recently the destruction wrought by
Hurricane Katrina in the Gulf Coast zone, devastation at a
scale that demands a capital market solution.
I'd also note that Congress exempted these special bond
programs from the individual AMT. This is a policy we strongly
endorse, and would encourage Congress to extend to all tax-
exempt private bond interests.
Congress has thoughtfully reviewed the municipal bond
market over the last several decades and shaped a system that
provides critical but limited Federal assistance, quickly,
directly, and efficiently. We thank you for the opportunity to
testify today and look forward to answering your questions.
[The prepared statement of Mr. Green follows:]
Statement of Micah Green, President and Chief Executive Officer,
The Bond Market Association
Thank you Chairman Camp and Ranking Member McNulty for the
opportunity to represent the municipal bond market at this hearing on
tax-preferred bonds. My name is Micah S. Green and I am President and
CEO of The Bond Market Association. While Association members include
participants in all the fixed-income and credit product markets, our
roots are traced to the $2.2 trillion tax-exempt municipal bond market.
Our municipal division is one of the most active in the Association and
its members underwrite 95 percent of the tax-exempt municipal bonds
issued by state and local governments to fund important public
infrastructure such as roads, schools and hospitals.
It is important to note at the outset of this statement that
Association members play an intermediary role on the municipal markets.
Bond dealers and underwriters generally are neither significant long-
term investors in, nor end users of, municipal financing. While we
believe the tax exemption for municipal securities is efficient and
effective, ultimately, our members would underwrite and trade any
securities issued by states and localities, no matter the nature of
their tax preference. The Association's conclusions in this statement
reflect our collective expert view of how the municipal bond market can
work most efficiently for all stakeholders--federal taxpayers, state
and local governments and investors.
Association members believe the municipal market is an efficient
and time-tested tool for delivering federal assistance to state and
local governments. Congress has monitored the tax exemption carefully
over the years and altered the tax laws governing the market when
viewed as necessary. Some of the most notable changes came with the
major reforms in the Tax Reform Act of 1986. As a result, the municipal
bond market today is a well-functioning system that efficiently
provides federal assistance for governmental and other public
purposes--such as the 9/11 and Katrina recovery efforts--specifically
approved by Congress.
The tax exemption for municipal bonds has proven its effectiveness,
and Congress should not enact changes that will affect it in a
fundamental way. There are some aspects of the Internal Revenue Code
(IRC), however, that could be modified to further improve the
efficiency of the market. For example, interest on certain tax-exempt
private-activity bonds is not exempt from the individual alternative-
minimum tax (AMT). These ``AMT'' bonds are used to finance projects
with an element of private participation specifically approved by
Congress. Potential AMT tax liability causes investors to demand a
higher interest rate, which increases the borrowing costs of the
issuer. The markets would also benefit from a relaxation of the limits
on advance refunding for governmental bonds. This would bring state and
local governments greater financial flexibility. Legislative proposals
to permit an additional advance refunding have gained significant
support in Congress over the last several years.
I. Background of the Municipal Bond Market
Municipal bond issuance by American cities dates to colonial times
in the 1700s. In 1812, New York City issued the first publicly recorded
municipal bond to finance the construction of a canal. By 1843, U.S.
cities had issued a total of $25 million, mainly to finance railroads.
The tax status of these bonds was understood by all at the time to be
constitutionally based under the doctrine of ``intergovernmental tax
immunity.'' In 1895, the Supreme Court explicitly and unanimously
affirmed the exemption of interest on state and local bonds. In the
case of Pollack v. Farmers' Loan and Trust Company, the Court found
that a federal tax on interest on municipal securities under the
Wilson-Gorman Tariff Act of 1894 was unconstitutional.
The Pollack case also held that an income tax more generally failed
to apportion taxation uniformly among the states as the Constitution
directed. This holding drove Congress to create a system of taxation
that could be applied to the entire population in a nondiscriminatory
way. The income tax--made possible by the 16th Amendment to the
Constitution--became that system. The first IRC adopted after passage
of the 16th Amendment specifically exempted interest on state and local
bonds from the federal income tax. Municipal bond yields immediately
fell in relation to corporate bonds and other taxable securities as
investors recognized the economic advantage of owning tax-exempt bonds.
Borrowing costs for state and local governments fell correspondingly.
While the Supreme Court had recognized the tax exemption for
municipal bonds as a constitutional right, Congress still made several
attempts to revoke that status. In 1923, lawmakers proposed a
constitutional amendment to authorize a federal tax on municipal bond
interest. The measure passed the House but not the Senate and was soon
forgotten. Other similar but less serious efforts to alter the tax
exemption also stalled in Congress in the 1930s and 1940s. The initial
AMT legislation proposed in 1969 would have made all municipal bond
interest taxable for AMT payers. Under the revisions to the AMT enacted
in 1986, only interest on private-activity bonds, as noted above, is
included.
In the 1970s, Congress also looked at giving state and local
governments the option to issue taxable bonds and receive an interest
subsidy from the federal government. The state and local governments
opposed the idea largely based on the concern it would give a federal
bureaucracy control over local financing decisions. The risk also
existed that Congress could withdraw the subsidy after the bonds were
issued.
The constitutional basis for the tax exemption was overturned by
the Court through the decision in the case of South Carolina v. Baker
in 1988. That decision upheld a provision of the Tax Equity and Fiscal
Responsibility Act (TEFRA) that made registration a condition of the
tax exemption. The Court also specified that the ability to grant and
maintain the tax exemption for municipal bonds rests solely with
Congress.
Municipal Bonds are an Efficient Form of Federal Assistance
One of the principal reasons Congress has maintained the special
status of municipal bonds is the public policy objective of providing
federal assistance for the financing by state and local governments of
projects such as schools, roads, hospitals, government buildings, low-
income housing and many others. As the Anthony Commission, a panel made
up of lawmakers, state and local government officials and market
participants, found in the early 1990s, each of these projects in turn
foster economic growth and development in our communities. This raises
tax revenue and lowers the cost of government services, which would
otherwise need to be provided by a bureaucracy of the federal
government. Of the options available to Congress, the tax exemption on
municipal bonds is clearly the most efficient way to provide financial
assistance to state and local governments. The main alternative, the
congressional appropriations process, has a single advantage from the
perspective of states and localities. It would be a cash grant. But for
a number of reasons, the fact a municipal bond must be repaid brings
great efficiency to the financing of public infrastructure. By
contrast, the appropriations process is slower, less focused and more
susceptible to political pressure that can distort the allocation of
resources. At a minimum, appropriations require Congress to take two
actions. First, a project must be authorized. Second, money to fund the
project must be officially designated--or appropriated. To achieve just
these initial steps involves overcoming routine obstacles such as the
congressional schedule and political competition from constituencies of
other appropriations candidates. Sound projects can lose out as limited
federal resources are directed to earmarked projects that may be
economically less worthy. It is common for a significant time lag to
occur between the authorization and appropriation steps, a period in
which project costs can only grow. The wait for federal funding can
leave state and local governments uncertain of how to best allocate
their own infrastructure funding resources for years at a time. And
while local input can be involved in the appropriations process,
decision making on important details of projects is often far removed
from the local level.
Once a project is authorized and appropriated, it faces a different
set of obstacles associated with the federal bureaucracy tasked with
its implementation. This usually takes the form of a lengthy review
meant to ensure the project conforms to an agency's rules.
By contrast, decisions as to which specific projects receive
municipal bond financing are appropriately made at the state or local
level. Often voters themselves make the decision through referenda. In
other cases, the question is left to a political body--a state
legislature or city council--that answers to the voters. In making the
decision to issue municipal bonds, governments typically analyze other
funding options such as raising fees or taxes. The process provides a
sort of political test to judge the importance of the project to the
community. This is a solely local test. Individual financing decisions
do not depend on input from or the approval of the federal government
as long as the project being financed meets the guidelines established
by Congress for the appropriate use of the tax exemption.
The process of issuing a municipal bond requires more than just
political approval by a state or local government. The bonds are
contracts to pay interest and repay principal, so the issuer must
maintain the confidence of investors that payments will be made. While
the majority of municipal bonds are held directly or indirectly by
individuals, it remains a market dominated by professional,
sophisticated investment managers. They perform careful due diligence
on all investments. Most bonds are reviewed and rated by a credit
rating agency. A majority of new bonds are insured by a bond insurance
company, which performs its own financial analysis of the viability of
a project before providing credit insurance coverage. Market
participants would not invest in--and underwriters could not bring to
market--bonds that were not adequately backed by fees, a specific tax
or the broader taxing authority of a state or local government. This
market test of municipal bonds also contributes to the market's overall
efficiency by providing a check against wasteful or infeasible projects
that would amount to a misuse of federal assistance and public
resources. The incentive to issue bonds only for the most necessary and
appropriate uses is reinforced by the fact that bonds are fundamentally
loans that must be repaid.
Some critics of the tax exemption for municipal bonds claim it
sacrifices part of the subsidy intended for issuers as a windfall to
investors. The analysis of returns realized by tax-exempt investors to
support this argument typically involves hypothetical examples
suggesting that certain investors earn excess after-tax returns on tax-
exempt bonds because they pay taxes at high marginal rates. The rates
are sometimes shown to be higher than the ``break-even'' tax rate
implied by the ratio of tax-exempt to taxable yields. If the ratio is
at 85 percent, for example, then an investor in a tax-exempt security
would earn a pre-tax return equal to 85 percent of the yield available
on a similar taxable bond. With a maximum marginal tax rate of 35
percent, the investor would appear to be earning a higher after-tax
return on the tax-exempt security than possible on the comparable
alternative taxable security. The difference, critics of the tax
exemption for municipal bonds have argued, represents a windfall to
investors at the expense of taxpayers that would not exist in an
efficient market.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
There are two key problems with this efficiency metric. First, it
assumes a marginal tax rate for municipal bond investors that is too
high given the ability of investors to achieve lower effective marginal
tax rates as a result of the 15 percent rate on qualified dividends and
long-term capital gains. A more realistic effective tax rate to use to
compare taxable and tax-exempt investments would be 25 percent, a blend
of the lower rate on dividends and capital gains and the highest
marginal rate on interest and other income. Second, this approach
typically uses U.S. Treasury securities as the comparable taxable yield
to measure the municipal yield ratio. But the difference in yield
between Treasuries and municipal bonds is a factor of much more than
just the tax-exemption. Treasuries are more liquid \1\ and of better
credit quality than any other security in the world. The Treasury
market is homogenous, deep and global. Treasuries are active
speculative and trading instruments held by institutional investors all
over the world. The municipal bond market, on the other hand, is
fragmented and less liquid. It is a diverse market with tens of
thousands of issuers and millions of outstanding issues and maturities,
many of them very small. It is a market confined to U.S. investors--
predominantly individuals or their proxies. Comparing municipal yields
to Treasuries inaccurately suggests tax-exempt investors earn a greater
return relative to taxable investments than is the case. The London
Interbank Offered Rate (LIBOR) is a better benchmark with which to
compare tax-exempt yields because it represents the interest rate
highly rated banks generally pay. Banks are closer to the credit
profile of municipal issuers than the U.S. government. If LIBOR is
substituted for Treasuries, the same comparison shows tax-exempt
municipal investors earning a much lower proportion of the yield on
taxable securities. For yields at a 15-year maturity--about the average
maturity for municipal bond issues--the average municipal-LIBOR yield
ratio on March 10 was about 77 percent. This suggests that an average
municipal bond investor was virtually indifferent between holding a
tax-exempt or taxable security.
---------------------------------------------------------------------------
\1\ In the capital markets, liquidity refers to the ability to
easily buy or sell an asset quickly and with a minimal transaction
cost. Treasuries are more liquid than municipal bonds because they are
more homogenous, are issued in very large issue sizes, and posses zero
credit risk. To the degree a bond lacks liquidity, investors demand a
liquidity premium in the form of higher yield.
---------------------------------------------------------------------------
But even using LIBOR as a benchmark, however, overstates the ratio.
LIBOR effectively represents noncallable bank bond yields. Correcting
for the unique characteristics and features of municipal bonds such as
call options and generally small issue sizes discussed below, municipal
yields would be lower and the ratio to LIBOR lower. Note in the above
graph that yield ratios for maturities greater than 15 years are above
what would be expected given the presumed 25 percent marginal tax rate
for municipal bond investors. These higher yield ratios largely reflect
the heightened call risk to investors associated with buying longer-
term municipal bonds.
Viewed in this light, the municipal market is very efficient
relative to taxable yields.
When considering the relative efficiency of the municipal market in
general, it is important to remember there is no practical alternative
as a means of delivering federal assistance. Tax-credit bonds, as
discussed below, are not a more efficient alternative. And leaving
state and local governments to finance all infrastructure projects
through the taxable markets by eliminating the tax exemption completely
would lead to dramatically higher borrowing costs.
Municipal bond issuers represent numerous and diverse credit risks.
They have unique financing needs filled by issuing small groups of
bonds in serial maturities, or series of bonds with sequential
maturities. This approach provides level debt service payments for
state and local borrowers similar to a self-amortizing mortgage loan.
It also contributes to market fragmentation. Consider that 74 percent
of municipal bonds issued are for $1 million or less.\2\ Large,
institutional investors who dominate the taxable bond market simply are
not interested in such a heterogeneous, diverse market dominated by
millions of small issues. In addition, most municipal bonds include
call provisions that give issuers financial flexibility but also cause
investors to demand higher yields. While these terms of issuance suit
the financing needs of state and local governments, they would also
make municipal bonds unattractive to institutional investors in the
taxable bond market. All but the very largest of municipal issuers
would have to pay significant premiums to investors in the form of
higher yields, which of course mean higher borrowing costs.
---------------------------------------------------------------------------
\2\ Report on Transactions in Municipal Securities (page 19),
Office of Economic Analysis, U.S. Securities and Exchange Commission,
July 1, 2004.
---------------------------------------------------------------------------
Moreover, the marginal buyer of a fully taxable instrument
reflected in Treasury or Libor yields is not a taxed U.S. investor. The
market for taxable U.S. credit instruments such as Treasury, agency or
corporate securities is dominated by four categories of investors: non-
U.S. central banks, foreign non-U.S. private investors, pension funds
that pay no taxes, and life insurance companies that have very low
marginal tax rates on investment income and do not benefit from the tax
exemption on municipal bonds. Individual investor ownership of taxable
fixed-income instruments has dropped dramatically in recent years \3\
and to the extent that it still exists, it is mostly in tax-deferred
accounts like 401(k)s and IRAs. In short, taxable bond yields are kept
low by demand from foreign sources. Surplus demand for dollar debt
securities among non-U.S. buyers is holding yields on large, liquid
taxable investments down by 50 basis points or more. U.S. borrowers
such as the federal government, corporations and the government-
sponsored enterprises like Fannie Mae and Freddie Mac benefit from this
situation through lower borrowing costs. Most of this benefit would not
be available to the bulk of state and local issuers, however, if they
were to issue taxable securities. The institutions that dominate the
taxable bond market are not interested in assets with the
characteristics of municipal bonds.
---------------------------------------------------------------------------
\3\ Flow of Funds, Z.1, (page 15), Federal Reserve Board, March 9,
2006.
---------------------------------------------------------------------------
II. Congress and the Municipal Market
While the tax exemption for municipal bonds faced the occasional
threat from Congress over the course of the 20th century, it was not
until the late 1960s that lawmakers enacted significant use
restrictions on the market. Congress, in 1968, limited the issuance of
tax-exempt bonds that benefit private parties to financings for a
specific list of eligible projects and in 1969 limited the use of
municipal bond proceeds for ``arbitrage'' purposes, or to invest in
higher-yielding securities. In 1984, lawmakers imposed the first cap on
the volume of private-activity bonds that can be issued by each state.
Tax Reform Act of 1986
With the sweeping reforms of the 1986 Act, Congress significantly
tightened the restrictions and limitations it had begun to implement in
the previous decades. The changes effectively reversed key rules
dealing with private use and arbitrage. The 1986 Act also restricted
the ability of issuers to advance refund \4\ municipal bonds and
eliminated banks as a source of demand by extending the pro rata \5\
rule.
---------------------------------------------------------------------------
\4\ An advance refunding occurs when a new tax-exempt bond and the
existing bond it was issued to repay are both outstanding for more than
90 days.
\5\ Pro rata refers to the requirement that corporations disallow
that portion of their interest expense deduction associated with
investment in tax-exempt municipal bonds. Corporations not involved in
the business of lending are exempt from the rule if tax-exempt bonds
comprise no more than 2 percent of their assets.
---------------------------------------------------------------------------
The 1986 Act reduced the types of projects eligible for tax-exempt
``private-activity bonds'' and significantly reduced the levels of
private benefit required to trigger those tightened limitations. Prior
to 1968, state and local governments had the discretion to issue tax-
exempt bonds for virtually any purpose. The restrictions put in place
in 1968, 1969 and 1986 defined the public purposes that are eligible to
benefit from the lower cost financing. And where up to 25 percent of a
bond's proceeds could be associated with private use before the 1986
Act, the limit is now 10 percent of a bond's proceeds. This change
effectively limited the ability to use municipal bonds to fund
activities with an element of private participation to instances where
the bond is solely dedicated to a qualified private purpose.
The 1986 Act also created a new approach to regulating how bond
proceeds can be invested. Instead of generally unrestricted investment
with the exception of the escrow fund in an advance refunding, all
investment became restricted or subject to a rebate unless specifically
excepted. As in 1969, this policy was driven by the practice of some
issuers to use earnings from the investment of bond proceeds to offset
the costs of bond-financed projects. In the context of the 1986 Act,
almost all such earnings were viewed as an abuse of the tax exemption
and Congress sought almost total elimination of arbitrage earnings.
The 1986 law also imposed arbitrage rebate requirements on state
and local governments. In addition to the requirement to restrict the
yield on the investment of bond proceeds, any arbitrage that might be
inadvertently earned must now be rebated to the federal Treasury.
Unfortunately, the calculations for determining whether and how much to
rebate can be extremely complex. For small, infrequent issuers, the
costs associated with complying with the rebate requirements can be
significant. The exceptions to the arbitrage rebate requirement in the
1986 Act were for issuers who sell less than $5 million in bonds
annually or in cases where bond proceeds to finance construction are
spent within a predetermined time period. In the 20 years since the
1986 Act, the industry has sought changes to the arbitrage provisions
such as an increase in the threshold amount for determining who is a
small issuer to account for inflation.
The 1986 Act also cut back on the ability of issuers of tax-exempt
municipal bonds issued for governmental purposes to conduct ``advance
refundings,'' or refinancing transactions where refunding bonds are
issued before the bonds being refunded are currently callable. Instead
of no refunding restrictions, under the 1986 Act, state and local
governments could advance refund governmental debt only a single time.
In limiting governmental issuers to a single advance refunding,
Congress reduced the cost in lost revenue to the Treasury but also
limited the financial flexibility of state and local governments. The
economic environment from 2001 to 2004 put the negative aspect of the
single advance refunding policy into a clear focus. Low market interest
rates combined with budget pressure created both the need and the
opportunity for many state and local governments to enter advance
refunding transactions. If issuers had the ability to take an
additional advance refunding at that time, it would have eased their
financial strains and possibly eliminated the need for other revenue
raising options--such as tax increases. For the past decade, the
Association has advocated permitting an additional advance refunding
precisely to provide state and local governments important financial
flexibility. Such a policy would not be a return to the unlimited
advance refunding authority prior to the 1986 Act, but would allow
state and local governments to maximize fiscal efficiency.
Another key change made by the 1986 Act eliminated banks as a
source of demand and left the municipal bond market dependent largely
on individual investors. Prior to the 1986 Act, banks could deduct from
taxes 80 percent of the interest cost associated with investment in
tax-exempt bonds. Under the changes, banks are automatically disallowed
a portion of their interest expense deduction for holding all but a few
excepted tax-exempt bonds. Banks, which had been a key source of
institutional demand, ceased to invest in tax-exempt bonds (with the
exception of qualified small issue bonds). Being restricted to a
largely retail investor base--individuals are the beneficial owners of
70 percent of municipal bonds--increased issuer borrowing costs. Retail
investors purchase bonds in smaller quantities than institutional
buyers which makes them more expensive to distribute.
Attempts to Raise Taxes on the Municipal Markets
Many of the restrictions placed on the use of tax-exempt financing
in the 1970s and 1980s were reasonable responses to perceived abuses of
the tax exemption. Some proposals, however, have represented
unjustified restrictions on the tax exemption. In December 1995, the
Clinton Administration proposed a number of provisions intended to
raise government revenue that would amount to huge tax increases on the
municipal market. The proposals would have increased the amount of tax
property and casualty insurance companies pay on what is otherwise tax-
exempt income. In addition, the proposals would have discouraged
corporations from buying municipal bonds by limiting interest expense
deductions for any corporation that earned any tax-exempt interest,
even if the corporation did not borrow to finance the purchase.
Corporations, and property and casualty insurance companies in
particular, are a critical source of demand in the municipal market.
This is especially true for certain sectors of the market. Congress
ultimately rejected the proposals.
III. The Municipal Market Today
The 1986 Act and its predecessors eliminated inappropriate
loopholes and potential for abuse from the municipal market and put in
its place an efficient mechanism for delivering federal assistance to
state and local governments. The market, however, continues to face
challenges under the continuing oversight of Congress. Issues under
consideration currently include whether certain groups or purposes
qualify for the tax exemption, potential alternatives to the tax
exemption and the fundamental efficiency of the municipal market.
Current Threats
Just over a year ago, the staff of the Joint Committee on Taxation
issued a report identifying $13.5 billion in municipal bond market tax
increases as options for Congress to consider in seeking to improve tax
compliance. In general, these provisions--such as the proposal to
eliminate advance refunding--did not address concerns of abuse. Instead
they represented changes in tax policy. The Association joined with a
coalition of state and local governments and other bond market
participants in opposition to the proposals. We have worked with
Congress to assure those provisions likely to be enacted are
implemented with minimum market disruption. For example, Congress is
likely to adopt new restrictions on pooled bond financing. The
Association is seeking to have state-level bond pools, which have not
been identified as a source of compliance problems, exempted from the
new restrictions. The Association is also urging Congress to change a
proposal to have issuers report taxpayer identification information to
the IRS, making it a reporting requirement of Association members
instead. Association members are currently required to provide the same
information for taxable bonds.
In our view, the IRS and Members of Congress are also concerned
with whether certain tax-exempt issuers are using tax-exempt financing
for purposes not intended under the current code. Audit programs in the
area are ongoing. To the extent such audits reveal real abuse of the
tax exemption, the Association supports the appropriate enforcement
action. Limited noncompliance by certain issuers, however, is not a
problem that requires broad legislative action.
Alternative Financing: Tax-Credit Bonds
The Subcommittee has asked about the relative efficiency of tax-
credit bonds as a means of financing public infrastructure projects.
Congress has only authorized three tax-credit bond programs to date for
a total of $5.15 billion, though far less has actually been issued.
From that limited experience, however, it is possible to draw two clear
conclusions about such a form of financing. First: tax-credit bonds--
which provide investors a return in the form of a tax credit, not an
interest payment--can provide a deeper subsidy than traditional tax-
exempt bonds. Second: tax-credit bonds would not constitute a more
effective alternative to providing federal assistance than traditional
tax-exempt bonds.
Tax-credit bonds are an unusual security with limited investor
demand. Under existing programs, the issuance of tax-credit bonds is
subject to conditions--such as a 10 percent matching contribution
requirement for Qualified Zone Academy Bonds (QZAB)--and the bond
itself has limited flexibility. The Association has commented
extensively on tax-credit bond programs in the past, recommending
structural changes that would win the securities greater market
acceptance. But even if Congress adopted all of these suggestions--
newer, limited programs have made key improvements--tax-credit bonds
would still lack a broad enough investor base to assure an efficient
market.
Congress first authorized tax-credit bonds in 1997 to provide
financing for improvements to public schools. Since then, lawmakers
have authorized only two new tax-credit bond programs: $800 million for
the Clean Renewable Energy Bond (CREB) program and $350 million to aid
the state and local governments in the Gulf Coast. CREBs were enacted
as part of the Energy Policy Act of 2005. The Gulf Opportunity Zone Act
authorized $200, $100 and $50 million in tax-credit bonds for
Louisiana, Mississippi and Alabama respectively.
At this writing, members of Congress have proposed a number of tax-
credit bond initiatives totaling billions of dollars. This includes
$225 million in Rural Renaissance tax-credit bonds in the Senate's tax
reconciliation bill.
QZABs, the only program under which tax-credit bonds have been
issued, have several critical flaws that the Association has addressed
before this and other congressional committees. For example, the timing
of the annual tax-credit may not match the needs of the investor. Only
banks, insurance companies and firms actively engaged in lending are
eligible to invest in the bonds, which limits demand and drives up
borrowing costs. The limited authorized issuance, the inability to
separate the tax credit from the underlying bond and restrictions on
qualified investors all hinder the liquidity of the security. Because
of all the limitations associated with tax-credit bonds, no QZAB issues
have resulted in zero-cost financing as designed. In all cases, issuers
have been required to offer additional compensation to attract
investors.
CREBs and the tax-credit bonds authorized in the Katrina-relief
legislation--along with many proposed tax-credit bond programs--reflect
most of the Association's concerns. The inability to strip the credit
and the small size and limited duration of the program, however, remain
as components of the programs and therefore obstacles to broader market
acceptance. While these tax-credit bond programs achieve the policy
goal of providing financing for a particular purpose, they do so in a
less efficient way than would traditional tax-exempt financing or a
direct appropriation. Such programs also add an additional cost in the
form of a new layer of federal bureaucracy to the process of financing
public infrastructure.
As noted above, even if such a tax-credit bond could be stripped
and issued in unlimited supply, along with other structural changes
needed to achieve maximum market acceptance, it would still remain a
less efficient alternative than the traditional tax-exempt market. The
liquidity premium inherent in municipal bonds would only be exacerbated
for the even more unique tax-credit bonds. Demand would be limited
largely to property and casualty insurance companies and a few other
investors with an interest in long-duration tax-preferred bonds. If
tax-credit bonds were issued in substantial quantities, the market
would quickly become saturated. Issuer borrowing costs would rise as
sagging marginal demand would force them to raise yields to lure back
investors.
The 2005 Tax Reform Panel Recommendations
In 2005, President Bush appointed his Advisory Panel on Federal Tax
Reform, with a mandate to focus on a fairer and more broadly based tax
code that promotes long-run economic growth. Most tax reform
discussions in recent years have included proposals to reduce or
eliminate taxes on savings and investment--a policy with potentially
huge benefits for the economy overall. The promotion of savings and
investment is important for our economy, but eliminating taxes on
savings and investment would also have implications for the tax-exempt
municipal bond market and for the finances of state and local
governments.
It is widely recognized that the transition to a new tax system
represents perhaps the most serious challenge in the debate.
Policymakers must consider whether the economic and social benefits of
a simpler and more streamlined tax code will outweigh the difficulties
that some will face in moving from the current to the new system.
In its final report, the President's Advisory Panel proposed two
options, one of which--the Simplified Income Tax Plan--would render
otherwise tax-exempt municipal bonds taxable for corporations. This
provision would significantly raise borrowing costs for state and local
governments.
Corporations hold approximately 30 percent of outstanding tax-
exempt bonds, and taking them out of the market would drastically raise
the cost to states and localities of financing public infrastructure
financed with municipal bonds. The proposal would leave the market
dependent on individual investors as the single source of demand for
municipal bonds. The problems raised by the Panel's proposal would be
magnified for state and local governments if another provision, the
elimination of deductions for state and local taxes, is also enacted.
The Panel did recommend eliminating the individual AMT as part of
both plans, a policy the Association actively supports.
IV. New Uses for Tax-Exempt Private-Activity Bonds
When faced with a crisis twice in the past five years, Congress
chose tax-exempt private-activity bonds as one of the many means of
providing federal financial assistance. In the wake of the terrorist
attacks of September 11, 2001, Congress created the Liberty Zone in
lower Manhattan and authorized $8 billion in special tax-exempt
private-activity bonds to aid in the long-term reconstruction of the
area. These Liberty Zone bonds were made available generally for non-
residential real property and residential rental property with a set
percentage of lower-income tenants. The legislation also permitted some
issuers of governmental bonds affected by the attacks to utilize an
additional advance refunding.
Following Hurricane Katrina, Congress tailored a package of tax-
exempt bond provisions similar to but more robust than those provided
in the Liberty Zone to address the reconstruction needs of the Gulf
Coast. Congress correctly recognized the scale of devastation in the
wake of Katrina was so great that reconstruction will require the
resources of the capital markets. The tax-exempt private-activity bonds
authorized in the Gulf Opportunity Zone Act, GO Zone bonds, can be used
to finance non-residential real property and qualified residential
rental property in the affected area. To date, $58.25 million in GO
Zone bonds have been issued by the Mississippi Home Corporation, that
state's housing finance agency. The GO Zone Act also permits an
additional advance refunding for all governmental and 501(c)(3) issuers
in the GO Zone subject to the statewide volume caps. Importantly, the
GO Zone Act also authorized one advance refunding for tax-exempt
private-activity bonds issued to finance airports, docks and wharves--a
significant shift in tax policy that recognizes the importance of
advance refunding as a financial tool.
Congress has clearly shown faith in the ability of the municipal
bond market to effectively deliver federal assistance in recent years
to include public education facilities, green buildings and road and
rail-truck transfer facilities. The latter authorization, in
particular, clears the way for the expanded use of public-private
partnerships for a critical area of public infrastructure.
Looking Ahead
In the case of the Liberty Zone and GO Zone, one of the policies
Congress chose to deliver federal assistance was advance refunding
authority. This recognition of advance refunding as an important
financial tool for state and local governments suggests Congress should
pass legislation granting an additional advance refunding for all
municipal bonds.
For similar reasons, the Association believes Congress should
exempt all tax-exempt private-activity bonds from the individual AMT.
This policy also has a limited congressional endorsement in both the
Liberty and GO Zone programs. Liberty and GO Zone bonds are not subject
to the individual AMT, an advantage that saves issuers from 15 to 25
basis points \6\ in borrowing costs.
---------------------------------------------------------------------------
\6\ A basis point is one hundredth of a percentage point.
---------------------------------------------------------------------------
Congressional revenue scorers might view such a policy shift as
losing revenues, but in practice any revenue loss would at most be only
transitory. As more investors are snared by the growing reach of the
AMT, they will realize the tax exposure they face in owning private-
activity bonds subject to the AMT. Such investors will move out of tax-
exempt private-activity bonds and into municipal bonds not subject to
the AMT. This will contribute to already shrinking demand for AMT bonds
and drive issuer borrowing costs higher. This dynamic also means it is
likely that exempting all private-activity bonds from the AMT would not
lead to a significant revenue loss for the Treasury, at least beyond
the near term. In the meantime, the AMT denies tax-exempt private-
activity bond issuers of the ability to borrow at the lowest cost
possible. Short of repealing the individual AMT altogether, the
Association urges Congress to exempt private-activity bonds from both
the individual and corporate AMT.
V. Conclusion
Tax-exempt municipal bonds are a proven national resource. Tax-
exempt municipal bonds provide the financing for public infrastructure
such as schools, roads and hospitals that improve the lives of
Americans every day. Congress has carefully reviewed the municipal bond
market over the last several decades and shaped a system it trusts to
provide critical federal assistance quickly and directly.
Municipal bonds benefit all Americans.
Chairman CAMP. Thank you very much. Thank you for your
testimony, Mr. Green. We had a pretty active day on the floor
today, legislatively, and a Subcommittee Member, Congressman
Doggett, asked me if I would ask a question for him for Mr. St.
Onge. His question is, what are the highlights of your tax
simplification report?
Mr. ST. ONGE. We submitted two reports, as I said in my
earlier remarks. In 2002, it was a lengthy report, detailing a
number of specific recommendations. In 2004, a shorter version
of that report was submitted to this Subcommittee. A couple of
the highlights; one area would be to modify and simplify
various arbitrage requirements, particularly those related to
rebate requirements, in order to make it simply easier to
administer those rules. We don't believe these recommendations
would fundamentally change the requirements of meeting the
rebate rules.
For example, one of the changes proposed would be to have a
simple, 3 year, spend down period for being exempt from the
rebate--rather than what is in place--which is a more
complicated process.
The other area that we recommended changes would be to
simplify the standard for what is a private activity bond. The
basic test is 10 percent private business use and 10 percent
private payments. We'd prefer to have that be the standard.
There are a number of subsidiary requirements that currently
exist, and impose additional requirements and complexity.
Given, in particular, the volume cap, we don't think that those
other rules are necessary to achieve the objectives.
The third item that I would mention would be we also
recommend repealing the AMT as it applies to private activity
bonds. We think that creates a distortion in the marketplace
that isn't warranted in this case.
Chairman CAMP. Thank you very much. I have a question for
Mr. Green, and then I'd ask Ms. Sledge to respond to the same
question, which is about the categories of bonds that have been
in recent legislation that have been allocated at the Federal
level. Do you think it would be more appropriate for that
bonding to be allocated at the state and local level, or if you
have any opinion on how the mechanism should be structured in
that situation?
Mr. GREEN. Well, if you hearken back to the 1986 Tax Reform
Act, where there were significant limitations put on the
issuance of private activity bonds, it is a much more limited
program--and that hearkens to the previous panel--and it's much
more controlled by two reasons. Number one, the definition of
what bonds can be issued for, and the overall volume caps.
As you look at specific problems, catastrophic problems,
like 9/11 and Hurricane Katrina, the ability to define an
allowable use of bonds for private activity purposes that was
not allowed under the existing law and allowing an additional
volume cap, or even a more open volume cap insures that the
Federal Government is meeting the national interest of helping
those areas rebuild after a catastrophic event.
By putting a limitation on it, I suppose you could say from
a Federal Government revenue standpoint, you're putting a
limitation on the revenue outflow, or the revenue expenditure.
From the standpoint of encouraging the activity and encouraging
the access to the capital markets to meet that national need,
you could almost argue that it's an arbitrary cap.
The decisionmaking of how you allocate it should be put
down on the local level. They are closer to it. They are the
ones putting their credit on the line. They are the ones
promising to pay back interest and principle, and that is what
defines as a partnership.
One could argue whether some uses should be without a cap.
One should argue whether some uses should be handled
differently to recognize they are clearly state and local
benefits.
Chairman CAMP. All right, and Ms. Sledge, do you have any
comment on that?
Ms. SLEDGE. Well, I certainly agree with the comments made
by my colleague, but I think you can tell from my testimony
that I am very passionate about the fact that the state and
local governments need to have the ability to issue their tax-
exempt bonds at that level.
They certainly need the flexibility to be able to respond
as quickly as they need to respond when they have to deal with
issues like Katrina or any other such natural disasters. To put
it on the Federal level, I think, would inhibit that
flexibility.
Chairman CAMP. You touched on this in your testimony, but
obviously the expansion over the last 20 years tax-preferred
bond financing through the private activity bonds. To what
extent has that expansion--what effect I guess--has that had on
state and local governments to finance what our traditional
government functions, bridges and roads and items like that.
Ms. SLEDGE. I think that the ability to enter into a
private partner relationship certainly enhances, in some cases,
the ability for state and local governments to build some of
the infrastructures that they need to build. Certainly the
state and local governments without private partner
relationships, but on the other hand, that relationship is
needed in order to build some of the infrastructures that the
public so much benefits from.
Chairman CAMP. Do you see this financing having an effect
on businesses' decision to locate or expand their facilities in
an area? Has that been your experience?
Ms. SLEDGE. It has especially been my experience. I can
tell you that, currently, as we speak, the ability to enter
into private-public relationships has enhanced our ability, in
some cases, to help build some more infrastructure. We are
currently speaking with several, well, a couple, at least,
private companies that are interested in coming and expanding
in the Wayne County area just for that reason.
Chairman CAMP. Thank you. Mr. St. Onge, in terms of
compliance, what procedures are in place to make sure that bond
proceeds are used as they are intended to be used?
Mr. ST. ONGE. Each bond issue that is done has in it a
series of covenants and promises to use the bond proceeds in
the appropriated manner. There is a variety of diligence that
is done prior to the actual issuance of the bonds by bond
counsel and the other market participants to insure that what
is being financed will, in fact, be financed. As I said, there
are covenants in place for the issuer and other participants in
the transaction to monitor that going forward.
In addition, the IRS has an active enforcement program in
place. It's been in place for about 10 years. The NABL actually
encouraged that, in part simply to help address what were
perceived to be some abuses in the market. That program has
also helped to identify and highlight particular problem areas.
One of the efforts that NABL has undertaken is to educate
our members and to work with the IRS to help identify what are
the areas of concern that they have on particular projects or
types of bond issues, and make sure that our members are made
aware of that as quickly as possible, so that they can help
also monitor those issues and deal with them in an appropriate
fashion.
Chairman CAMP. So, there are covenants when they enter into
the agreements. After the bonds are issued, are there any
procedures in place? Obviously you have an education program in
place. Are there any other follow up procedures that they have,
or that you're aware of?
Mr. ST. ONGE. Well, it will vary from transaction to
transaction, issue by issue. Most issuers are repeat borrowers
in a municipal market. It's rare that someone actually does a
single bond issue and you never hear from them again.
So, in fact, the continuing process of working with the
issuer for subsequent transactions often leads to follow-up
questions as to what's going on, what has happened to that
earlier project.
There are also opportunities to refund transactions,
refinance them for interest rate savings. In that context, it
also opportunities to follow up as to what's going on with
those projects.
Chairman CAMP. Mr. Green, you wanted to comment?
Mr. GREEN. Yes. Mr. Chairman, I would add that the
municipal bond market is both a primary market when bonds are
issued and a secondary market where bonds, once they're issued,
can be bought and sold. When an investor needs to sell a bond,
there has to be a liquid market out there for to buy that bond.
That involves constant market discipline and analysis and
review of outstanding issues and how they're performing under
the covenants that my colleague mentioned.
Also there are now, under the Federal Communications
Commission rules, significant and ongoing disclosure
requirements by state and local issuers to inform the
marketplace of the continued viability of the revenue stream,
or whatever the project was issued for.
So, there is an ongoing check in the system, and that's
called the capital marketplace. Now, with so many of the bond
issues that are now credit enhanced, in other words insured,
the bond insurers help insure, too, that the viability of the
underlying project continues on.
Chairman CAMP. I have a question. Thank you for that. Mr.
St. Onge, in 1986, Congress prohibited the use of private
activity bonds for sports stadiums, but most of those are being
built now with tax-exempt government bonds. Are these current
use limitations effective if state and local governments can
issue bonds to finance that type of facility anyway? Did you
have any comment on that?
Mr. ST. ONGE. I think that in most cases where a
governmental entity issues bonds for a sports facility, it's
doing so as a governmental bond. While there may be private
use, it's a fairly complicated analysis to determine whether or
not that is going to far over the line, and therefore creates
an impermissible private activity bond.
However, this involves an area where, frankly, the purposes
of the governmental entities, the economic development
activities that governments undertake today is very different
from what it was 20 years ago, 30, 50 years ago; in terms of
the range of activities that governments are expected to
provide and the sorts of services that their citizens want them
to provide or to help develop as part of the overall economic
development activities.
Fifty years ago, for example, in Massachusetts, there were
questions as to whether affordable housing projects were a
permissible public purpose. Today, there's no question that
that is the case. It is pretty settled. The same thing is true
with urban renewal projects and other economic development.
Initially there were questions raised, is that the proper
function of government. I think today those questions are
settled. The sports area presents another example of that.
However, those particular projects also require careful
analysis by the tax lawyers in the particular transactions to
insure that they do comply with the appropriate rules.
Chairman CAMP. Well, thank you all very much. I'm about
ready to conclude the hearing, if anyone had any closing
comments that they'd like to make. Mr. Green.
Mr. GREEN. Not enough to prolong the hearing, but just to
make one statement about the efficiencies of the markets,
because the prior panel, particularly the gentleman from CBO,
talked about that.
Frankly, we feel very satisfied, that when you look at the
total picture--not just the efficiency of the interest rate
subsidy as it relates to other like price securities in the
marketplace--the cost of the administration of the program, the
lack of a Federal bureaucracy to support that program, the
pushing down of local decisionmaking, and the speed with which
local governments can act, compared to a Federal appropriations
allocation process. That when you take that all together, it
really is an efficient program.
On the interest rate side, those who say it's inefficient
are comparing it with the U.S. Treasury market, which is the
largest, most global, most liquid, largest investor-based
marketplace in the world. When you compare the municipal bond
interest rate with other similarly situated indexes for similar
types of securities on the taxable side, it actually is a very
efficient market.
Chairman CAMP. Well, I really appreciate all of your
patience as we had this long delay this morning. I want to
thank you all for your excellent testimony. This is very
helpful to the Subcommittee. I appreciate it very much.
At this time, the Subcommittee on Select Revenue Measures
is adjourned.
[Whereupon, at 1:09 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
Aeration Industries International
Chaska, Minnesota 55318
March 23, 2006
The Honorable Bill Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
Dear Chairman Thomas:
I am writing on behalf of our company in support of H.R. 1708, the
Clean Water Investment and Infrastructure Security Act. Aeration
Industries International, Inc. (AIII), founded in 1974, is a Minnesota-
based corporation that solves a variety of water treatment problems.
The Company introduced aspirator aeration technology into the water
treatment market under the trademark, ``AIRE-O2''.
Today, Aeration Industries is a world leading manufacturer of aeration
equipment and wastewater treatment systems serving the municipal and
industrial wastewater treatment industry and aquaculture market. The
Company has solved the most challenging water treatment problems using
superior, proprietary technologies and engineering expertise based on
30 years of field experience. Aeration Industries has more than 4,000
installations located in all 50 states and in more than 85 countries
around the world.
We should all be concerned about the deteriorating state of our
nation's water and wastewater infrastructure. Nearly $1 trillion
dollars needs to be invested over the next 20 years to repair,
rehabilitate, replace and upgrade our nation's network of water and
wastewater treatment plants, collection systems and distribution lines.
Failure to stem this looming crisis will cause significant public
health and economic harm to our country.
H.R. 1708 will allow communities across the nation to partner with
the private sector in funding critical water infrastructure activities
by removing water and wastewater projects from the state volume caps
for private activity bonds. This is the least expensive option for
addressing a growing national crisis and ensuring that all Americans
are guaranteed a safe, reliable water infrastructure system. We urge
Congress to move expeditiously on this proposal and thank you for your
leadership in this matter.
Sincerely,
Dan Durda
President and CEO
American Forest & Paper Association
March 28, 2006
Subcommittee on Select Revenue Measures
Committee on Ways and Means
Room 1135
Longworth House Office Building
Washington, D.C. 20515
Dear Sir or Madam:
On behalf of the Tax Exempt Bonds Recycling Coalition
(``Coalition''), I am pleased to submit the following testimony for the
record in the Subcommittee hearing related to tax-preferred bond
financing held on March 16, 2006. The Coalition thanks the Subcommittee
for this opportunity to provide its views on the importance of the use
of tax-exempt bonds to finance solid waste recycling facilities. The
Coalition is committed to working with Congress, the Treasury
Department and the Internal Revenue Service in the establishment of
fair and appropriate laws, regulations and rules promoting recycling
through the issuance of tax-exempt bond financing for these facilities.
Sincerely,
David Koenig
Director, Tax Policy
______
The American Forest & Paper Association (``AF&PA'') on behalf of
the Tax Exempt Bonds Recycling Coalition (``Coalition'') thanks
Chairman Camp, Ranking Member McNulty, and the other Members of the
Subcommittee on Select Revenue Measures, Committee on Ways and Means
for the opportunity to submit testimony for the record on tax-exempt
financing for paper-related solid waste disposal facilities. This tax-
exempt financing is crucial to achieving the Nation's recycling goals.
The Coalition commends the Subcommittee for holding this hearing on the
critical topic of tax-exempt bond financing.
The Coalition is comprised of companies, trade associations,
environmental groups, and state and local governments all having a
common interest in promoting public policy that supports recycling. The
AF&PA, the national trade association for the forest products industry,
represents more than 200 companies and related associations that engage
in or represent manufacturers of pulp, paper, paperboard and wood
products. AF&PA member organizations employ approximately 1.3 million
people and rank among the top ten manufacturing employers in 42 states.
Recycling of paper and paperboard is a vital component of the
Nation's recycling efforts. The AF&PA estimates that paper comprises
nearly 80 percent of the materials recovered in community recycling
programs. In 2004, the United States recovered for recycling nearly 50
percent of the paper consumed, breaking the 50 million ton mark for the
first time. Paper and paperboard recovery has increased by 73 percent
since 1990. Successful recycling efforts to date have resulted from
effective legislation enacted by Congress to encourage and facilitate
recycling, considerable investment and effort by private and public
stakeholders in the paper recycling process, and dedication on the part
of millions of Americans who recycle at home, work and school. In 2003,
the amount of paper recovered for recycling averaged 339 pounds for
each person in the United States. To keep up with growing demand for
high quality recovered fiber, the industry has set an aggressive goal
to increase recovery to 55 percent by 2012. This recycling activity
helps protect the environment, provides a substantial number of jobs,
and results in economic stimulus in many communities throughout the
United States.
Congress has enacted a series of measures over the years to
strongly support recycling policies (such as the Solid Waste Disposal
Act of 1965 and the subsequent Resource Recovery Act of 1970),
encourage the preservation of our natural resources, and reduce the
amount of land needed for landfills.
In addition, the tax law provides very important incentives for
financing of recycling facilities, and specifically authorizes issuance
of tax-exempt bonds to promote recycling though the financing of solid
waste disposal facilities. Over the years, these tax rules have
provided a critical financing tool for the development of recycling
facilities, and Congress has shown strong support for these rules.
Bonds issued to finance solid waste disposal facilities must meet a
number of technical requirements to qualify as tax-exempt. For example,
these bond issuances are subject to the unified State volume cap
applicable to qualified private activity bonds. Additionally, existing
Treasury Department regulations define the term ``solid waste'' as
property which is useless, unused, unwanted or discarded material that
has no market or other value at the place where it is located.
(Treasury Regulation sec. 1.103-8(f)(2)(ii)(b)).
Regrettably, a 1998 Technical Advice Memorandum (``TAM'') issued by
the Internal Revenue Service (``Service'') has created substantial
uncertainty as to the availability of tax-exempt financing for solid
waste recycling facilities, resulting in a severe ``chilling affect''
on the issuance of such financing. In TAM 199918001, the Service held
that a payment to a supplier for solid waste material will deny
classification of the material as solid waste for purposes of the tax-
exempt bond financing requirements. The TAM did not reflect the fact
that the material at issue was useless, unused, unwanted or discarded
at the point of collection (for example, in a community waste
collection stream). Additionally, the TAM did not allow for service
costs involved in handling, collecting, separating, sorting, baling,
and transporting the solid waste material to the recycler.
Members of Congress and numerous industry groups have expressed
concern to the Treasury Department and the Service that the uncertainty
created by the TAM inappropriately restricts the use of tax-exempt
bonds for financing solid waste recycling facilities in direct
contravention of Congressional intent. For example, a bipartisan letter
dated June 12, 200l, signed by 31 Members of the Committee on Ways and
Means, was sent to then Treasury Department Secretary Paul H. O'Neill
and then Internal Revenue Service Commissioner Charles O. Rossotti
stating ``. . . the policies articulated in the TAM undermine
congressional intent.'' The letter further states that the TAM
effectively would thwart solid waste disposal policies by denying tax-
exempt bond financing for recycling facilities while allowing such
financing to landfills and municipal waste incinerators.
In 2002, the Treasury Department and the Service requested public
comments on the existing regulations and rules governing tax-exempt
financing for solid waste disposal facilities. After receiving public
comments, the Treasury and Service in 2004 issued proposed regulations
(REG-140492-02) (``Proposed Regulations'') that would make numerous
revisions to the existing regulations. The Proposed Regulations delete
the requirement that qualifying solid waste have ``no value.'' The
preamble to the Proposed Regulations states that in light of the
changes that have occurred in the waste recycling industry since the
existing regulations were issued in 1972, the no-value test is
eliminated for determining whether material is solid waste. The
Proposed Regulations, however, contain numerous provisions which the
Coalition and other commentators believe must be modified in order to
provide fair and appropriate guidance on these important matters.
The Coalition has been very active throughout this period in
providing comments and recommendations to assist the Treasury
Department and the Service in the analysis of these issues. The
Treasury and Service have placed this regulatory project on the 2005-
2006 Guidance Priority List. Recently, the Coalition submitted a
comprehensive set of comments to the Proposed Regulations. The
Coalition is committed to working with the Treasury and the Service to
analyze these vital regulatory issues to assist in the issuance of fair
and appropriate guidance. The Coalition's recommendations for
modifications to the Proposed Regulations may be briefly summarized as
follows:
1. Definition of Solid Waste. The Coalition agrees with the
Treasury and the Service, that the ``no-value'' element of defining
qualified solid waste should be eliminated. The Coalition recommends
that the appropriate definition of solid waste should include garbage,
refuse, or discarded solid materials that are useless, unused,
unwanted, or discarded.
2. Solid Waste Disposal Function. The Coalition recommends
revising the definition of a solid waste disposal function to insure
that future scientific and technological developments created to
process solid waste will be covered by the new regulations. The
Coalition notes that one shortfall in the Proposed Regulations is the
``lock-in'' effect limiting qualifying solid waste disposal functions
to four types of processes, which definition soon could become obsolete
from both scientific and technological standpoints.
3. Definition of Solid Waste Disposal Process. In the case of a
procedure designed to process the solid waste into a useful product,
the Coalition recommends defining the process of implementing the solid
waste disposal function as beginning at the collection, separation,
sorting, treatment, disassembly, or handling of the solid waste and
ending at the point at which the solid waste material has been
converted into a material or product that can be sold in the same
manner as a comparable product produced from virgin material
(regardless of whether the product is actually sold at that point in
the process). The Coalition recommendation contains several examples of
the application of this important standard and we believe is consistent
with existing rules.
4. Deletion of the Concept of ``Preliminary Function.'' The
Coalition believes that if an appropriate definition of the entire
solid waste disposal process is crafted, there is no need for a
separate category defining a class of preliminary activities. The
Coalition recommendation alleviates the need for the concept of a
preliminary function, thereby simplifying significantly the structure
of the regulations.
5. Treatment of Mixed Input Facilities. The Coalition recommends
retaining the current law rules related to the treatment of mixed input
facilities and the safe harbor as provided under current law and
practice. The Proposed Regulations would set standards that are overly
harsh and very difficult to administer in practice.
6. Effective Date. The Coalition recommends that for the
appropriate administration of the tax law, taxpayers should be able to
elect to apply the new regulations on a retroactive basis.
The Coalition's recommendations to modify the Proposed Regulations
as summarized above would set standards for the issuance of these tax-
exempt bonds that are reasonable, fair and administrable, and would
effectuate Congressional intent to provide appropriate economic
incentives in support of recycling policies. The Proposed Regulations
as so modified should be finalized as expeditiously as possible, in
order to end the current ``chilling affect'' on tax-exempt financing of
solid waste recycling facilities, and to restart the tax-exempt
financing of these vital projects.
The Coalition thanks the Subcommittee for this opportunity to
provide its views on this very important aspect of the Nation's
recycling policies. The Coalition is committed to working with
Congress, the Treasury Department and the Service in the establishment
of fair and appropriate laws, regulations and rules promoting re-
cycling through the issuance of tax-exempt bonds to finance solid waste
disposal facilities.
Statement of the American Public Power Association
The American Public Power Association (APPA) appreciates this
opportunity to submit comments for the record in the above-referenced
hearing. APPA is the national service organization representing the
interests of the more than 2,000 state and locally owned electric
utilities collectively serving over 43 million Americans. As not-for
profit units of state and local government, these public power
utilities are authorized to issue tax-exempt bonds to construct and
improve the infrastructure necessary to provide electricity and other
essential services, such as advanced communications services.
Electricity is the oxygen of the nation's economy; vital to its
continued health. Continued access to, and flexibility in the use of,
tax-exempt bonds is of huge importance in allowing public power
utilities to continue to provide these services, and to do so in a
cost-effective manner.
Our comments will briefly focus on the following points:
The infrastructure benefits derived from both continued
access to tax-exempt bonds and allowance of a certain level of private
activity;
The impact of continuing, dramatic changes in wholesale
electricity markets on infrastructure needs and financing flexibility;
and
The increase in proposals to use taxable-tax-credit
bonds.
Tax-Exempt Bonds Finance Essential Utility Infrastructure
To address societal needs, increase productivity, and make our
nation more competitive in the global marketplace, we must invest in
America's infrastructure. Tax-exempt municipal bonds are the basic tool
used by states, cities, counties, towns, school districts and other
governmental entities to fund the capital improvements necessary to
provide needed facilities and services. The ability to sell debt with
interest exempt from federal income taxes has been a significant
benefit to state and local government borrowers, including public power
utilities, in providing essential public facilities.
The nation's public power utilities are units of state or local
government created to provide essential services subject to local
control. Their historic and current day focus is on providing their
citizens with the best possible electric service at the lowest possible
cost. They have financed their electric utility infrastructure-
generation, transmission and distribution facilities--just as local
governments have financed other municipal activities: through the
issuance of tax-exempt bonds. Public power utilities currently have
over $80 billion in outstanding tax-exempt bonds.
Traditionally, our federalist system of government has respected
the right of state and local governments to pursue activities that are
in the public interest and the interest of the citizens they serve.
Congress has promoted and protected the right of government to issue
municipal bonds for ``government owned and operated projects and
activities.'' Public power systems are just that--governmentally owned
and operated systems similar to other local infrastructure projects
such as water systems, prisons, libraries, schools, hospitals, and
transportation lines.
In addition to continued access to tax-exempt bonds to finance
electricity infrastructure, it is important that Congress provide
adequate flexibility in the ability of public power utilities to
partner with private entities in the financing and use of certain
facilities. High-voltage transmission lines and large generating
plants, for example, are often constructed to serve multiple producers
and users based on their economies of scale. Moreover, they can be
difficult to site given the substantial land use involved and
frequently cited environmental and aesthetic concerns. Furthermore,
generation facilities, which are typically constructed to last 30 years
or more, are often sized to meet both current and future electricity
demand. That means surplus power may be available in early years for
sale to other utilities. Some ability to make that power (or
transmission capacity) temporarily available to other suppliers without
running afoul of the private use restrictions on tax-exempt bonds used
to finance the relevant facilities provides multiple benefits to all
parties, without transferring the benefits or burdens of the bond
financed facilities to private parties.
Congress has recognized this necessary flexibility by allowing a
certain amount of ``private use'' from output facilities financed with
tax-exempt bonds. Prior to the 1986 Tax Reform Act, the limitation on
private use was set at 25 percent for all governmental bond issues.
However, in 1986 Congress amended the Internal Revenue Code (the
``Code'') to reduce the amount of permissible private use to no more
than 10 percent. In addition to the reduction of the private use
limitation from 25 percent to 10 percent, the Code also provides that
for certain output facilities--which include public power generation,
distribution and transmission assets--the private use limit per output
project is further limited to the lesser of 10 percent of the issue or
$15 million per project. Private use restrictions limiting the benefits
available to private entities from publicly financed facilities are
based on sound and appropriate public policy considerations. However,
we believe that the private use restrictions should apply equally to
all governmentally financed and operated facilities.
The special $15 million private-use limitation is not supported by
any public policy justification and causes undue burden and complexity.
It may force local governments that provide generating and transmitting
facilities to have their surplus capacity sit idle rather than having
it sold to others in order to avoid the private use limitation. This
provision should be repealed because it is discriminatory and it
encourages practices that are neither environmentally nor economically
sound.
Another important element of flexibility in the use of tax-exempt
bonds is the ability to advance refund bonds in order to take advantage
of more favorable interest rates. This ability has saved public power
utilities and their customers hundreds of millions of dollars over the
past twenty years. It has also allowed public power to maintain more
stable rates, even as electricity markets continue to suffer from ill-
conceived de-regulation efforts and high price volatility. Proposals
have been advanced that would eliminate the ability to advance refund
bonds. We urge the subcommittee to reject such proposals because they
would simply increase the cost of electricity. Instead, we urge the
subcommittee to support the ability of issuers to have an additional
opportunity to advance refund outstanding bonds in order to lower
electricity infrastructure costs and ultimately the rates to consumers.
APPA is also aware that there has been some concern expressed in
recent years by the Internal Revenue Service, the Joint Committee on
Taxation, and others about alleged abuses of tax-exempt bonds. APPA and
governmental issuers in general do not condone abuses or illegal use of
tax-exempt bonds. However, while we have seen expressions of concern
about such abuses and heard some discussion, frankly, we have yet to
see any evidence of such abuses. Congress should not act to impose
additional restrictions or requirements in the absence of verifiable
evidence of abuse. Tax law changes that were made in the 1986 Tax
Reform Act and other changes thereafter have placed many limitations on
the tax-exempt bond market in the name of ``curbing abuse.'' Yet the
outcome has been an overreaching impact on the overwhelming majority of
the marketplace where abuses do not exist. As importantly, Congress
should provide the necessary resources to the Treasury and Internal
Revenue Service to vigorously enforce the law using the considerable
and effective tools already available to them in the tax code.
Significant Changes in Wholesale Electricity Markets Highlight the Need
for Continued Access to, and Flexibility in the Use of, Tax-
Exempt Bonds
As mentioned above, electricity markets, especially wholesale
markets, are continuing to experience significant problems in market
design and function, as well as extreme price volatility. In
particular, wholesale markets run by centralized Regional Transmission
Organizations or Independent System Operators (RTO-run markets) are
experiencing major flaws in market design and operation that are
resulting in increasing, and increasingly volatile, wholesale prices
for electricity. Increases in rates for wholesale power are also
occurring as a result of increases in the price of fuels used to
generate electricity, primarily natural gas and coal. Natural gas
prices have increased as a result of supply shortages, and coal prices
have been driven up through monopoly practices by the railroads that
deliver the coal to power plants. However, while fuel prices affect the
cost of electricity in all regions of the country, not just those with
RTO-run markets, prices in regions with RTO-run markets are higher than
those in non-RTO regions.
RTO market design features such as ``locational marginal pricing''
for managing transmission congestion and single bid clearing auctions
for short term sales of electricity are not meeting their intended
objectives. Instead, they are increasing the cost of wholesale power
and serve as a disincentive for investments in new power plants and
transmission lines. In addition, these factors and other policies of
RTO-run markets converge to severely limit the ability of electric
utilities, including public power, to secure long-term power supply
arrangements or transmission service. This situation is of critical
importance to public power utilities since they, unlike many investor-
owned utilities, have not relinquished their legal obligation to serve
all customers in their communities in the states that have adopted
retail competition in electricity.
As the states, like Maryland and Virginia, and the District of
Columbia, that imposed retail rate caps as part of retail electricity
competition programs begin to see the term of those caps expire, retail
customers are experiencing rate shock. Recent articles in the Wall
Street Journal, Baltimore Sun and Washington Post chronicle these
problematic developments in detail. And the situation is likely to get
worse before it gets better.
In response to this market dysfunction and the resulting price
increases, public power utilities are placing a much greater emphasis
on self-reliance. They are increasingly building their own power plants
and, where they can, bulk transmission lines to ensure their ability to
meet their legal obligation to serve all customers and to do so at
reasonable prices. This new infrastructure will be financed with tax-
exempt bonds. Thus, it is imperative that public power utilities
continue to have access to and flexibility in the use of, tax-exempt
bonds.
Tax-Credit Bonds Can Be an Appropriate Additional Financing Tool for
Limited, Targeted Purposes
We understand that one issue of concern to the subcommittee is the
proliferation of proposals to use taxable-tax-credit bonds. There are
only two existing programs for tax--credit bonds, the Qualified Zone
Academy Bond program and the Clean Renewable Energy Bond (CREB)
program. Both are relatively small programs, $400 and $800 million
respectively. Additionally, because the CREB program was authorized as
part of the Energy Policy Act of 2005, there is little context with
which to review its successes and challenges. However, as qualified
issuers under the CREB program, public power utilities are
enthusiastically looking forward to using these new bonds to
substantially increase the amount of energy produced from renewable
sources. APPA believes that the CREB program is a good example of the
appropriateness of using taxable-tax-credit bonds in limited, targeted
circumstances.
At the same time we want to be perfectly clear that tax-credit
bonds are not, and should not be viewed by Congress, as an alternative
to tax-exempt bonds for financing state and local government activities
and related infrastructure, but should instead be used in a targeted
way to achieve specific public policy goals--like increasing renewable
energy production that will result from the use of tax-credit bonds in
the recently-enacted CREB program. CREBs were authorized for a very
specific purpose--to provide public power utilities with an incentive
for renewable energy production comparable to the incentive provided to
private energy developers through the production tax credit under
Section 45 of the Code. Moreover, these are new, relatively untested
financial instruments for which there is currently a limited market.
This program needs some experience and maturity in order to evaluate
its overall benefits. In addition, it is already clear to APPA that
some refinements and streamlining of the CREB program would improve its
effectiveness and we look forward to discussing those matters with the
subcommittee in the future.
APPA does share some concern as well regarding over-proliferation
and inappropriate use of tax-credit bonds. One clear example is Section
569 of S. 2020, the Senate tax reconciliation bill now pending in
conference. This provision would allow non-governmental entities (in
this case, electric cooperatives and their wholly-owned financing
institutions) to issue tax-credit bonds to build facilities such as
police and fire stations, wastewater treatment plants, low-income
housing units, and other facilities and services provided by state and
local governments. Cooperatives are private businesses, thus the entire
benefit of this proposal is for private activity. This does not strike
us an appropriate use of this benefit.
Conclusion
Congress should not limit the continued access to tax-
exempt bonds by public power utilities to finance electricity
infrastructure because tax-exempt municipal bonds are the basic tool
used by public power to provide their citizens with the best and most
economical electricity and other essential services, such as advanced
communications services.
Additionally, Congress should provide adequate
flexibility in the ability of public power utilities to partner with
private entities in the financing and use of certain facilities. APPA
urges that Congress repeal the special $15 million private use
limitation that applies only to publicly-owned electric and gas
facilities utilities and is not supported by any public policy
justification.
Congress should reject proposals to eliminate the ability
to advance refund bonds because they would simply result in increasing
the cost of electricity. APPA urges the subcommittee to support the
ability of issuers to have an additional opportunity to advance refund
outstanding bonds in order to lower electricity infrastructure costs
and ultimately the rates to customers.
Because electricity markets are continuing to experience
significant problems in market design and function, as well as extreme
price volatility, APPA urges Congress to allow public power utilities
to be able to increase self-reliance through the development of new
infrastructure financed with tax-exempt bonds.
Finally, APPA strongly believes that the use of tax-
credit bonds should not be viewed by Congress as an alternative to tax-
exempt bonds for financing state and local government activities, but
should instead be used in a targeted way to achieve specific public
policy goals--like increasing renewable energy production that will
result from the use of tax-credit bonds in the recently-enacted CREB
program.
Environment One Corporation
Niskayuna, New York 12309
March 23, 2006
The Honorable Bill Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
Dear Chairman Thomas:
I am writing on behalf of our company in support of H.R. 1708, the
Clean Water Investment and Infrastructure Security Act. Employing 180
constituents, Environment One Corporation is an operating company of
Precision Castparts Corp. (NYSE: PCP), a worldwide manufacturer of
complex metal parts and industrial products. With corporate
headquarters in New York and regional offices and distribution
throughout the industrialized world, E/One is a manufacturer and
provider of products and services for the disposal of residential
sanitary waste.
We should all be concerned about the deteriorating state of our
nation's water and wastewater infrastructure. Nearly $1 trillion
dollars need to be invested over the next 20 years to repair,
rehabilitate, replace and upgrade our nation's network of water and
wastewater treatment plants, collection systems and distribution lines.
Failure to stem this looming crisis will cause significant public
health and economic harm to our country.
H.R. 1708 will allow communities across the nation to partner with
the private sector in funding critical water infrastructure activities
by removing water and wastewater projects from the state volume caps
for private activity bonds. This is the least expensive option for
addressing a growing national crisis and ensuring that all Americans
are guaranteed a safe, reliable water infrastructure system. We urge
Congress to move expeditiously on this proposal and thank you for your
leadership in this matter.
Sincerely,
Philip Welsh
President
Flowserve
Taneytown, Maryland 21048
March 27, 2006
The Honorable Bill Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
Dear Chairman Thomas:
I am writing on behalf of Flowserve in support of H.R. 1708, the
Clean Water Investment and Infrastructure Security Act. Flowserve has
been a leading manufacturer of equipment for the Water and Wastewater
market for over 100 years. Our company employs thousands of people
worldwide and is committed to the people and communities we serve.
We should all be concerned about the deteriorating state of our
nation's water and wastewater infrastructure. Nearly $1 trillion
dollars need to be invested over the next 20 years to repair,
rehabilitate, replace and upgrade our nation's network of water and
wastewater treatment plants, collection systems and distribution lines.
Failure to stem this looming crisis will cause significant public
health and economic harm to our country.
H.R. 1708 will allow communities across the nation to partner with
the private sector in funding critical water infrastructure activities
by removing water and wastewater projects from the state volume caps
for private activity bonds. This is the least expensive option for
addressing a growing national crisis and ensuring that all Americans
are guaranteed a safe, reliable water infrastructure system. We urge
Congress to move expeditiously on this proposal and thank you for your
leadership in this matter.
Sincerely,
James Sivigny
Water Resources Marketing Manager
Hach Company
Loveland, Colorado 80539
March 30, 2006
The Honorable Bill Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
Dear Chairman Thomas:
I am writing on behalf of the Hach Company in support of H.R. 1708,
the Clean Water Investment and Infrastructure Security Act. Hach has
manufactured water analysis instrumentation and has been active in
addressing water and wastewater issues for over 40 years.
We at Hach believe the deteriorating state of our nation's water
and wastewater infrastructure is a significant issue that that needs to
be addressed at both the local and Federal level. Nearly $1 trillion
dollars need to be invested over the next 20 years to repair,
rehabilitate, replace and upgrade our nation's network of water and
wastewater treatment plants, collection systems and distribution lines.
Failure to stem this looming crisis will cause significant public
health and economic harm to our country.
H.R. 1708 will allow communities across the nation to work with the
private sector in funding critical water infrastructure activities by
removing water and wastewater projects from the state volume caps for
private activity bonds. This can be a cost effective option for
addressing a growing national crisis and ensuring that all Americans
are guaranteed a safe, reliable water infrastructure system. We urge
Congress to move expeditiously on this proposal and appreciate your
leadership in this matter.
Sincerely,
Jonathan O. Clark
Vice President
JWC Environmental
Costa Mesa, California 92626
March 23, 2006
The Honorable Bill Thomas, Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
Dear Chairman Thomas:
I am writing on behalf of our company in support of H.R. 1708, the
Clean Water Investment and Infrastructure Security Act. Our company,
JWC Environmental, has been active in the wastewater industry for 33
years. Although a small company, with annual sales of about $45 million
and 150 employees, we are very important in our local Southern
California community, which features very few manufacturing companies
in today's climate. All of our manufacturing is done locally here in
Orange County.
We should all be concerned about the deteriorating state of our
nation's water and wastewater infrastructure. Detailed industry studies
have shown that nearly $1 trillion dollars need to be invested over the
next 20 years to repair, rehabilitate, replace and upgrade our nation's
network of water and wastewater treatment plants, collection systems
and distribution lines. Failure to stem this looming crisis will cause
significant public health and economic harm to our country.
H.R. 1708 will allow communities across the nation to partner with
the private sector in funding critical water infrastructure activities
by removing water and wastewater projects from the state volume caps
for private activity bonds. This is the least expensive option for
addressing a growing national crisis and ensuring that all Americans
are guaranteed a safe, reliable water infrastructure system. We urge
Congress to move expeditiously on this proposal and thank you for your
leadership in this matter.
Please do not hesitate to contact me for further information.
Sincerely,
Fritz Egger
Director of Sales & Marketing
Large Public Power Council
March 30, 2006
Congressman Dave Camp
Subcommittee on Select Revenue Measures
Committee on Ways and Means
1100 Longworth House Office Building
Washington, D.C.
Dear Congressman Camp:
I am writing on behalf of the Large Public Power Council (the
``LPPC'') to provide comments for the record of the Subcommittee's
March 16, 2006 hearing on the use of tax-preferred bond financing. As
described in detail below, the LPPC supports the appropriate use of
both tax-exempt bonds and tax credit bonds.
The LPPC is an association of 24 of the largest governmentally
owned electric utilities in the United States. Our members include not
only the largest governmentally owned retail systems in the country but
also a number of wholesale sellers of electricity that serve
municipally owned retail systems. Our members serve approximately 18
million retail customers and own and operate electric generation
facilities that produce over 11,610,000,000 megawatt hours of
generation annually. In addition, the members of the LPPC own and
operate approximately 26,000 circuit miles of transmission lines. Our
members are located throughout the country, including California,
Colorado, Arizona, New York, Texas, Washington, Florida, Georgia,
Nebraska, and South Carolina.
LPPC members have approximately $50 billion of tax-exempt bonds
outstanding. Our members use tax-exempt bonds to finance electric
generation, transmission, and distribution facilities for use to serve
their customers. The LPPC's members are political subdivisions and
other governmental entities that have always been authorized to issue
tax-exempt bonds, provided that the Internal Revenue Code's private
activity, arbitrage, and other limitations are satisfied. Our members
are traditional governmental entities who have, for many years,
provided critical electric infrastructure facilities which, in recent
years, have only grown in importance. As the Subcommittee's
announcement states, the Tax Reform Act of 1986 (the ``1986 Act'') made
significant modifications to the rules for tax-exempt bonds in an
effort to limit the use of tax-preferred bond financing to support
private activities. The LPPC's members issue ``governmental bonds''
rather than private activity bonds and, as a result, are permitted to
finance all of their capital needs as long as the amounts of private
business use do not exceed permitted levels. The 1986 Act substantially
reduced the amount of permitted private business use for all
governmental bonds and there has been no liberalization of these rules.
Moreover, no other issuers of governmental bonds were restricted to the
extent that public power systems--particularly large public power
systems--were limited. Generally, the 1986 Act reduced the amount of
permitted private business use from 25 percent to 10 percent (and, in
certain instances, to 5 percent). For public power issuers, the amount
of permitted private business use is the lesser of 10 percent of the
proceeds of the issue (or 5 percent in certain instances) or $15
million per project. This means that for any public power project with
a cost greater than $150 million, the private business use limitation
is $15 million. Since many electric generation projects cost hundreds
of millions of dollars, the private business use limitation for public
power issuers can be as little as 2 or 3 percent. Although this $15
million for private use limitation was aimed at preventing abuse, as a
practical matter it is inconsistent with energy policy and the
realities of constructing large new generation and transmission
projects. Given the long useful life of these projects, their large,
costs, and economics of scale, these generation projects are built to
serve a public power system's customers both today and long into the
future. As a result, it is necessary to size these projects to take
into account the expected growth in the needs of the owner's customers;
to build a facility large enough for today but not tomorrow would be
foolish and wasteful. As a result of this, it is often necessary for
public power systems to sell relatively small portions of the output of
their new facilities to other utilities as the owner grows into those
facilities. As a result, the $15 million rule imposes additional costs
on customers during the early years of the facility's life or compels
the system to keep the electricity unavailable to other utilities who
need it to satisfy the needs of their customers. Clearly, this makes no
sense from an energy policy perspective. No other issuer of
governmental bonds is subject to this $15 million limitation, and as a
result, it impacts only those governmental entities (and their
customers) where it makes the least sense. We urge that Congress repeal
the $15 million private use limitation on public power financing.
In addition, subsequent to the 1986 Act, Congress enacted Section
141(d) of the Internal Revenue Code, which further restricted public
power's use of tax-exempt bonds by generally prohibiting the use of
tax-exempt bonds to finance the purchase of privately owned electric
facilities. Further, the deregulation and restructuring of the electric
industry have resulted in additional difficulties for public power's
use of tax-exempt bonds under the private activity bond limitations
enacted as part of the 1986 Act. The need to comply with the private
use rules in a deregulated market has, at times, limited public power's
participation in the deregulated market or forced public power systems
to forgo the use of tax-exempt financing for their faculties.
In short, although the private activity bond restrictions limit the
ability of public power systems to use tax-exempt bonds to benefit
private activities as intended, they also prevent public power from
engaging in legitimate transactions that further national energy
policy. We are unaware of any suggestion that public power systems have
used tax-exempt bonds in connection with any abusive transactions.
Based on this, we believe that Congress should not impose additional
limitations on public power's use of tax-exempt bonds. In fact, we
believe that it is appropriate for Congress to consider simplification
of the private use and other limitations to achieve a better balance
between complexity and preventing abuse.
The electric industry is capital-intensive and, as a result, public
power systems in general, and the LPPC in particular, are substantial
issuers of tax-exempt bonds. Despite this fact, the volume of tax-
exempt bonds issued by public power issuers has not increased
dramatically over the past 10 years.
There is another aspect to public power's use of tax-exempt bonds
to finance electric generation and transmission facilities that should
be recognized. In recent years, the problems with the supply of
electric generation and transmission capacity in the United States have
been well documented. It has been repeatedly recognized by both
government and industry officials that the United States is in drastic
need of additional transmission and generation. More than any other
industry sector, it is public power that has been responding to this
need and building the new generation and transmission that the country
requires. It would be counterproductive to introduce new limitations on
how public power finances these facilities given the critical need for
additional generation and transmission.
We also will address two points made by the Congressional Budget
Office (``CBO'') in its testimony. First, CBO stated that governmental
entities can circumvent the limitations on private activity through
partnerships with private entities. This is incorrect. The applicable
IRS rules contain extensive limitations on every means of private
entity involvement, including partnerships and management or service
contracts. If anything, these rules go too far in limiting governmental
entities from accessing private entity expertise in operating their
facilities. CBO also suggested that there is a lack of IRS efforts to
monitor compliance with the rules for tax-exempt and tax credit bonds
and, as a result, Congress should impose monitoring requirements on
issuers. Again, we disagree. Although relatively new, the IRS has an
effective, growing audit program for tax-exempt bonds. As in other
areas, the IRS relies on audits of a portion of the bond market to
achieve its compliance goals. In the tax-exempt bond area, levels of
noncompliance have been relatively low and seem to involve relatively
discrete, non-traditional financings such as blind pools and not public
power. At the same time, issuers of tax-exempt bonds must comply with
the tax rules to protect the bondholders, with whom the issuers
covenant to protect tax-exempt status. As a result, imposing tax
compliance monitoring requirements or the tax-exempt bond market would
needlessly impose substantial costs on every issuer in order to deal
with the noncompliance of a small percentage of the market. This
suggestion should be rejected.
Clean renewable energy bonds. The Subcommittee's hearing
announcement indicates that it would like to examine the use of tax
credit bonds to provide tax-preferred bond financing for new
activities. The first tax credit bond enacted was for qualified zone
academy bonds (``QZABs''), which are designed to provide low cost
financing for certain educational facilities. As part of the Energy
Policy Act of 2005 (the ``Energy Policy Act''), Congress provided for
the issuance of clean renewable energy bonds (``CREBs''), a tax credit
bond for renewable energy facilities. The Energy Policy Act contained
an extensive set of tax provisions designed to provide tax benefits to
a wide variety of energy-related projects, including a number of new
and expanded tax credits.
For many years, the Internal Revenue Code has provided a production
tax credit (Code section 45) for renewable energy projects with no
corresponding provision to assist public power systems and cooperatives
in building renewable generation. Congress could have permitted
renewable energy projects of public power systems and cooperatives to
obtain federal funding by making the production tax credit tradable or
by adequately funding a more direct form of subsidy for these projects
through the Department of Energy's Renewable Energy Production
Incentive (``REPI'') program. Under the REPI program, DOE provided
direct payments to public power systems and cooperatives. However, this
program was subject to appropriation and since its creation in 1992 was
never adequately funded. As a result, Congress chose to create CREBs to
provide public power and cooperatives with a subsidy that is relatively
comparable to the production tax credit through the issuance of tax
credit bonds. Given that public power systems have been in the
forefront of the movement to greater use of renewable energy, with many
public power systems voluntarily adopting their own renewable portfolio
standards, the LPPC was extremely gratified by the enactment of the
CREB provisions.
From a public policy perspective, it is clear that the nation needs
greater use of renewable energy. In fact, the President in his State of
the Union address this year stated that the development of alternative
sources of energy is a top priority of this country. There are,
however, restrictions on the CREBs program that substantially reduce
its effectiveness. In particular, the CREBs program sunsets in two
years and has a volume cap that ensures that only a small fraction of
the qualifying projects will benefit from CREBs. In contrast, there are
no volume limitations on the projects that are eligible for the
production tax credit. In addition, Treasury has decided to allocate
the volume cap in a manner that will result in small projects getting a
substantially disproportionate benefit from the program. The manner in
which Treasury establishes the credit rate for CREBs is also
problematic. Finally, the CREBs legislation contains maturity
limitations on CREBs that will limit the effectiveness of CREBs as a
financing tool. Treasury has acknowledged its difficulties in
allocating the limited amount of CREBs and in setting credit rates for
CREBs. Although still a new program, Congressional input on the CREBs
program, particularly regarding Treasury's methods of allocating CREBs
volume cap and setting credit rates, is needed. Given the size of the
program and limits on Treasury's resources, creative solutions are
needed to address these problems.
Although CREBs did not exist prior to the Energy Policy Act, we do
not believe they should be viewed as providing a new subsidy. First,
for public power systems, these projects have always qualified for tax-
exempt bond financing and have been financed with tax-exempt bonds in
the past. Second, Congress had already recognized renewable energy
facilities as worthy of federal subsidies when the production tax
credit and REPI programs were enacted. Unfortunately, neither the
production tax credit nor the REPI program was structured in a way that
provided an effective federal subsidy for public power systems and
cooperatives. Thus, the enactment of CREBs should be viewed as a
modification of existing federal programs for renewable energy
facilities to provide a viable subsidy for the renewable energy
projects of public power systems and cooperatives. While economists can
argue that tax credits and direct subsidies are more efficient, those
forms of assistance have not been made available to public power for
renewable energy projects. At the same time, we recognize that,
compared to the tax-exempt bond market, tax credit bonds are an
imperfect method of financing projects. While to economic policymakers
tax credit bonds may appear to be more efficient than tax-exempt bonds,
in practice, the tax-exempt bond market has proven to be very efficient
and must continue to be the method that the vast majority of
governmental projects are financed.
For the reasons described above, we believe that public power's use
of tax-exempt bonds and tax credit bonds are more than adequately
limited. Given the present state of the nation's electric
infrastructure, we can think of no greater public benefit from the use
of tax-preferred bond financing than the improvement and expansion of
the electric generation and transmission system.
Sincerely,
Noreen Roche-Carter
Chair, Tax and Finance Task Force
National Association of Higher Educational Facilities Authorities
Omaha, Nebraska 68124
National Council of Health Facilities Finance Authorities
Pierre, South Dakota 57501
March 30, 2005
The National Association of Higher Educational Facilities
Authorities (NAHEFA) was incorporated in 1988 for the purpose of
promoting the common interest of issuers of tax-exempt financing for
non-profit educational institutions and to enhance the effectiveness of
such organizations and their programs. The Association's members focus
on issues that directly influence the availability of tax-exempt
financing for non-profit educational institutions.
The National Council of Health Facilities Finance Authorities
(NCHFFA) was incorporated in 1987 for the purpose of promoting the
common interest of the governmental issuing authorities that provide
tax exempt financing for not-for-profit hospitals and health care
facilities and to enhance the effectiveness of its member institutions.
The Council focuses on issues that directly influence the availability
of tax-exempt financing for health care.
32 states have these authorities, and we also represent 4 local,
specialized authorities.
In their states, NCHFFA/NAHEFA members operate a variety of
programs to assist non-profit, educational institutions and health care
providers in gaining access to the lowest interest rates available,
thereby saving for each project tens of thousands of dollars annually
which can then be used for faculty, staff, nurses and providing greater
assistance to students or patients. Members have financed projects such
as academic buildings, new dormitories, science laboratories, libraries
and elementary and high schools as well as hospitals, facilities for
the aging and community centers. Due to the activity of NCHFFA/NAHEFA
member authorities, there is approximately $100 billion in capital
project financing outstanding for nonprofit, charitable, educational
and healthcare institutions throughout the United States.
Tax-exempt bond financing is crucial to the success and enhancement
of many charitable, higher education and healthcare facilities. Every
increase in capital costs decreases the services available to students
and patients. The key role of charitable healthcare and not-for-profit
education was recognized when the Internal Revenue Code provisions on
tax-exempt bonds were revamped in 1986, by the Anthony Commission on
Public Finance Report in 1989 and in actions by Congress and the
Administration since then, including special provisions for 501(c)(3)
financings in Katrina relief legislation.
NCHFFA and NAHEFA have supported legislative and regulatory
provisions that prevent abuses in tax-exempt bond financing, including
in our sectors. However, we strongly support the continued use of tax-
exempt bond financing by legitimate charitable, healthcare and higher
education institutions. Any significant limitations on bond financing
in these sectors would create adverse consequences for higher education
and healthcare providers and their students and patients. These
organizations require regular and major amounts of capital and their
vital role in the nation's economy would be threatened by undue
restrictions.
Not-for-profit organizations are unable to access the equity
markets, private contributions are unable to satisfy all of their
needs, and government grants are extremely limited for capital
projects. Therefore, much of the capital needs for not-for-profit
healthcare and higher education organizations must be financed with
debt. There is no question that the federal government and the states
provide support and incentive to the enhancement of these institutions
by allowing tax-exempt rather than taxable debt but we believe that
such support is a wise policy choice. Tax-exempt debt means that
institutions confront interest rates which are substantially lower and
maturities significantly longer. These factors make much needed
projects affordable due to lower debt service payments.
Arguments about appropriations and other direct financing of
projects now financed by tax-exempt bonds are interesting intellectual
speculation, but the reality is that the federal appropriations process
is far from efficient and rational. Many of the appropriations and
grants for charitable activities have been significantly reduced over
time. We commend to the Committee the excellent analysis by the Bond
Market Association on the efficiency of tax-exempt bonds as compared to
taxable and other methods of financing projects.
The combination of state authorization and rules for the governance
of issuers plus federal regulation provides an appropriate balance
within our system of federalism. Basic decisions about whether projects
should be financed should be made at the state and local level while
Congress and the IRS protect against abuses of tax-exempt bonds. We
believe that, as prior to 1986, qualified 501(c)(3) bonds should not be
considered private activity bonds (even with the present exemptions)
but rather as public purpose bonds when the 501(c)(3) organization's
use of tax-exempt bonds is exclusively for charitable exempt
activities. 501(c)(3) organizations, when operating appropriately,
provide public services that are broad based in nature and that would
otherwise have to be provided by a governmental entity, particularly in
healthcare and education.
Concerns raised about the qualifications of certain 501(c)(3)
organizations for tax exemption and the proper roles and activities of
organizations, such as charitable hospitals, should be dealt with
directly by the Congress and the IRS and not through the indirect and
artificial means of limitations on tax exempt-bond issuances. To the
extent that there is Congressional concern with the scope or operation
of certain exempt purpose organizations, Congress should impose
restrictions directly on such activities rather than amend the tax-
exempt bond provisions. In connection with its current review of
Section 501(c)(3) issues, Congress should satisfy itself that the
criteria under Section 501(c)(3) are appropriate to assure that
qualifying organizations operate in a manner consistent with Congress's
view of proper public purposes.
NCHFFA and NAHEFA support the enhancement of the marketplace for
tax-exempt bonds for healthcare and higher education. We are strong
supporters of Mr. Nussle's legislation, H.R. 1140, which would amend
the Internal Revenue Code to liberalize existing rules which greatly
restrict ``bank deductibility'' of tax exempt bonds for smaller
charitable healthcare and educational institutions. This legislation is
aimed at focusing the existing exemption at the level of the
institution's borrowing rather than at the level of the unrelated
issuers' total issuances in a calendar year.
With respect to new forms of tax-preferred financing, such as tax-
credit bonds, NCHFFA/NAHEFA view this development with some skepticism.
Although some of these mechanisms are creative and interesting, it is
unclear that they serve any purpose that is not fully satisfied by
traditional tax-exempt bond financing. It is undesirable to create a
system of non-uniform federal restrictions on various bonds. These
bonds also divest state and local authorities and their citizens of
control over what financing should occur. Rather than make an already
complicated system much more complicated without clear commensurate
benefit, we do not support an extension of this type of financing
without clear demonstration that they create benefits that cannot be
accommodated by the present public finance system.
We appreciate the Committee providing this opportunity for NCHFFA/
NAHEFA to submit testimony and will be glad to provide further
information as requested.
Respectfully submitted,
Linda Beaver
President NAHEFA
Donald A. Templeton
President NCHFFA
Robert Donovan
NCHFFA/NAHEFA Advocacy Chairman
Charles A. Samuels
Counsel to NCHFFA/NAHEFA
Statement of the National Association of Local Housing Finance Agencies
The National Association of Local Housing Finance Agencies (NALHFA)
appreciates the opportunity to present its views to the Subcommittee on
Select Revenue Measures, House Committee on Ways and Means regarding
its comprehensive review of tax-preferred bond financing. NALHFA is a
non-profit association of city and county government agencies, and
their private sector partners, who finance affordable housing using a
variety of sources, including federal tax code incentives, to attract
private investment in affordable homeownership and rental housing
opportunities for low-and moderate-income families. NALHFA strongly
urges the Subcommittee to preserve and protect these incentives
discussed in more detail below.
Affordable Housing Tax Code Incentives--Tax-Exempt Bonds
Local housing finance agencies (HFAs), and their state agency
counterparts, utilize the authority provided under the Internal Revenue
Code to issue several types of tax-exempt bonds to expand affordable
housing opportunities for low-and moderate-income households. Among
these are Mortgage Revenue Bonds (MRBs), which provide mortgage
financing for first-time homebuyers; and, on the rental housing side,
through tax-exempt multifamily bonds which are either private activity
bonds, essential function bonds, or 501(c)(3) bonds.
In order to issue tax-exempt private activity bonds, issuers must
receive an allocation of bond authority from the unified state volume
cap. The volume cap is calculated as the greater of $75 per capita or
$225 million per state per year (indexed for inflation), and may be
used for a variety of purposes including affordable housing, ``small
issue'' industrial, student loans, solid waste, and qualified
redevelopment bonds.
Mortgage Revenue Bonds (MRBs) and Mortgage Credit Certificates
(MCCs)--Local housing finance agencies issue tax-exempt MRBs under the
authority of Section 143 of the Internal Revenue Code of 1986 to
provide first mortgage assistance to low-and moderate-income first-time
homebuyers--the people that the conventional market often leaves
behind. Typically, the tax-exempt bond-financed interest rate is as
much as 1.5 percent below the convention interest rate, although the
spread has been much less for the past several years as the nation has
enjoyed very low interest rates for conventional loans. In addition to
being a first-time homebuyer, i.e. not having owned a home in the
previous three years, to be eligible for MRB assistance, borrowers must
have incomes no higher than 115 percent of the area median for
households of three or more or 100 percent for households with less
than three persons. There is an exception to these limits in certain
targeted areas. In addition, the homes financed must have a purchase
price no greater than 90 percent of the average area purchase price.
Should a homebuyer sell the residence in which he/she lives within the
first ten years, a recapture of the imputed subsidy is required to be
paid to the Treasury.
In addition to providing first mortgage assistance, MRBs are also
issued for qualified home improvement loans and qualified
rehabilitation loans. Qualified home improvement loans cover repairs or
improvement to an existing home by the owner to improve basic
livability or energy efficiency of the residence. The amount of the
loan may not exceed $15,000 (although this ceiling was increased to
$150,000 for areas affected by last year's hurricanes).
Local housing finance agencies use MRBs for one or more public
purposes:
Providing homeownership opportunities for targeted
households;
Promoting new affordable housing construction through
builder set-asides;
Stimulating housing rehabilitation and home improvements;
Promoting substantial rehabilitation, thereby encouraging
neighborhood revitalization;
Stabilizing and improving neighborhoods through
homeownership; and
Attracting residents to, and retaining them within, inner
cities.
Local housing finance agencies may also elect to exchange all or
part of their annual unused bond authority to issue mortgage credit
certificates (MCCs) in lieu of MRBs. MCCs entitle qualifying
individuals to a credit against their federal income tax liability for
a specified percentage of the annual interest paid on a mortgage to
purchase, improve or rehabilitate a home. Issuers may offer a rate from
10 to 50 percent. However, for credits in excess of 20 percent the
amount of the credit is capped at $2,000. MCCs generally are subject to
the same eligibility and targeting requirements applicable to the MRB
program, including income, purchase price and target area set-aside.
Credits are usable for the life of the mortgage so long as the
mortgagor maintains the home as his/her principal residence. In order
to maximize the value of an MCC, the mortgagor has to have sufficient
tax liability. MCC programs tend to work best in areas with high
housing costs.
Congress worked very hard in both the 1986 Act, as well as
subsequent statutes, to limit the amount of issuance of MRBs and other
tax-exempt private activity bonds by use of a volume cap as well as
sharply targeting both the households assisted and the cost of the
housing that can be purchased. In 2004 (the latest year for which data
is available), local housing finance agencies issued an estimated $3.7
billion of the $14.9 billion used for MRBs through out the nation. This
essential tool for expanding homeownership and assisting in
neighborhood revitalization must be preserved for low-and moderate-
income American first-time homebuyers.
Multifamily Housing Bonds--Local and state housing finance agencies
use tax-exempt bonds to stimulate construction and substantial
rehabilitation of rental housing meeting certain targeting requirements
set forth in the Internal Revenue Code. They may issue private activity
bonds pursuant to Section 142 (d) of the Code for residential rental
projects. To qualify for such financing, a project must have at least
20 percent of the units set-aside for those households whose incomes do
not exceed 50 percent of the area median income, adjusted by household
size, or at least 40 percent of the units set-aside for households
whose incomes do not exceed 60 percent of the area median income,
adjusted for household size. The balance of the units may be rented to
households paying market-rate rents.
Multifamily bonds may also be combined with Low-Income Housing Tax
Credits. The Low-Income Housing Tax Credit program was created by
Congress in the Tax Reform Act of 1986 to generate equity capital for
the construction and rehabilitation of affordable rental housing for
lower income households. They are usually used with other forms of
subsidy because no one subsidy is sufficient to produce an affordable
rental housing project. The credit replaced traditional tax incentives
for investment in low-income housing (passive losses) that were
eliminated by the same Act. The credit is a reduction in tax liability
for an individual or corporate taxpayer each year for ten years that is
based on the costs of development and the number of low-income units.
The tax credit rate is approximately 4 percent for acquisition costs, 9
percent for rehabilitation and new construction costs, but only 4
percent if a project has federal subsidies (other than Community
Development Block Grant or HOME funds) or tax-exempt financing.
Properties qualifying for the tax credit (for a minimum 15-year
compliance period) must have set-aside 20 percent of the units at or
below 50 percent of area median income or 40 percent of the units at or
below 60 percent of the area median income, with residents paying no
more than 30 percent of their incomes for rent. The tax credit program
is subject to a statewide volume cap set at the greater of $1.75 per
capita or a minimum of $2 million. Housing credit allocating agencies
must develop plans on how they will allocate credits, giving preference
to projects that serve the lowest income households for the longest
period of time. They must also evaluate and underwrite projects
carefully to insure that they award them the least amount of credits to
ensure financial feasibility. Projects that are tax-exempt bond-
financed do not require a separate allocation of tax credits. Tax
credits are typically syndicated to investors who may claim credits
against taxable income. The amount of tax credits that individual
investors may claim is $9,900 per year due to passive loss
restrictions. Corporate investors may claim an unlimited amount of tax
credits. Fannie Mae and Freddie Mac are the two largest purchasers of
Low-Income Housing Tax Credits.
In 2004, local housing finance agencies issued an estimated $5.7
billion of the $7.7 billion in tax-exempt multifamily private activity
bonds. Local and state housing finance agencies may also issue other
types of tax-exempt multifamily bonds including ``essential function''
bonds in which the agency issuing the bonds is the owner of the
project. Housing finance agencies may also issue tax-exempt bonds under
Section 145 of the Code on behalf of non-profit entities qualifying for
tax-exemption under Section 501 (c)(3) of the Internal Revenue Code,
subject to a limitation of $150 million in bonds outstanding for any
single non-profit entity at any one time. Under current law, both types
of bonds [essential function and 501(c)(3)], if not used solely to
acquire existing properties, are exempt from the targeting requirements
and volume cap applicable to private activity bonds. None-the-less,
issuers usually require some type of income restrictions for a portion
of the units.
In addition to the types of bonds mentioned above, general
obligation bonds are occasionally used for affordable housing. These
bonds are backed by the full faith and credit of the issuing
governmental entity and are not subject to federal restrictions as to
targeting or the amount that may be issued. They may, however, be
subject to state restrictions. Often it is necessary to obtain voter
approval before issuing such bonds.
Tax-exempt private activity bonds are subject to the Alternative
Minimum Tax.
These tax-exempt multifamily housing bonds serve a public purpose
by expanding rental housing opportunities for lower income renters.
Recommedations
NALHFA strongly urges the Subcommittee and the Congress to preserve
the tax-exemption applicable to single and multifamily housing bonds.
In an era of shrinking federal domestic spending, these tax code
incentives are essential for local housing finance agencies to expand
affordable ownership and rental housing opportunities for low-and
moderate-income families. This housing bond program does not require a
large federal bureaucracy to administer and thus minimizes the
administrative cost to the federal government.
In addition, NALHFA strongly urges the Subcommittee and the
Congress to remove tax-exempt private activity bonds from the
Alternative Minimum Tax. This tax code requirement increases issuance
costs for tax-exempt private activity bonds by as much as 50 basis
points, diverting resources that local housing finance agencies could
otherwise use for expanding affordable housing activities.
Finally, NALHFA urges the Subcommittee and the Congress to preserve
the so-called ``two-percent de minimus rule'' which currently
encourages corporate investment in tax-exempt housing and other bonds.
Under this safe harbor rule, corporations which invest in tax-exempt
housing bonds may deduct the interest costs, in an amount up to two
percent of their assets, associated with such investments without
having to demonstrate that they did not use borrowed funds for the
purchase. Preservation of this rule is necessary to maintain the
corporate market for housing bonds. Fannie Mae and Freddie Mac in
particular are active purchasers of state and local housing finance
agency bonds and in 2004 constituted an estimated 36% of the market for
housing bonds. Their private placement purchases result in issuance
cost savings that local housing finance agencies can otherwise use to
assist in expanding affordable housing opportunities.
Thank you for the opportunity to present NALHFA's views.
Statement of National Association of Water Companies
Mr. Chairman, on behalf of the National Association of Water
Companies (NAWC) I would like to thank you for providing us the
opportunity to submit testimony regarding the federal tax treatment of
private activity bonds (PABs) for water and wastewater facilities.
NAWC is the only national organization exclusively representing all
aspects of the private and investor-owned water industry. The range of
our members' business includes ownership of regulated drinking water
and wastewater utilities and the many forms of public-private
partnerships and management contract arrangements. NAWC has more than
150 members, which in turn own or operate thousands of utilities in 38
States around the country.
NAWC endorses H.R. 1708, the Clean Water Investment and
Infrastructure Security Act, introduced by Representative Clay Shaw
(FL) and supports its earliest possible enactment.
H.R. 1708 would remove water and wastewater from under the state
volume caps on PABs. This simple change would make capital both easier
to obtain and less expensive for partnerships between the public and
private sector on water projects, thus making such partnerships much
more economically attractive to all concerned.
The Need for Increased Investment
According to recent reports by the Environmental Protection Agency
and the Congressional Budget office the annual estimated need for
investment in water and wastewater investment ranges from $20 to $40
billion a year. The specific projects vary from locality to locality,
but the magnitude and downside for inaction is staggering.
According to EPA's data, 880 publicly owned treatment works receive
flows from ``combined sewer systems'' which commingle stormwater with
household and industrial wastewater and frequently overload during
heavy rain or snowmelt. EPA estimates that such overflows discharge 1.2
trillion gallons of stormwater and untreated sewage every year. Even
``sanitary'' systems with separate sewers for wastewater can overflow
or leak because of pipe blockages, pump failures, inadequate
maintenance, or excessive demands. According to a draft EPA report,
overflows from sanitary sewers alone result in a million illnesses each
year. Moreover, according to industry experts, many urban and rural
drinking water systems lose 20 percent or more of the water they
produce through leaks in their pipe networks.
In part, those problems result from the aging of the nation's water
infrastructure, particularly its pipes. Though less visible than
treatment facilities, pipes actually account for the majority of both
drinking water and wastewater systems' assets. According to estimates,
drinking water systems have 800,000 miles of pipes, and sewer lines
cover more than 500,000 miles.
The rule of thumb is that a sewer pipe lasts 50 years (although
actual useful lifetimes can be significantly longer, depending on
maintenance and local conditions), and a 1998 survey of 42 municipal
sewer systems found that existing pipes averaged 33 years old,
suggesting that many are, or soon will be, in need of
replacement.Similarly, a study by the American Water Works Association
that analyzed 20 medium-sized and large drinking water systems
concluded that the need to replace pipes will rise sharply over the
next 30 years as previous generations wear out.
Although treatment plants represent a smaller share of water
systems' assets than pipes do, they too are aging. Equipment in many
plants built under the Clean Water Act and Safe Drinking Water Act will
need to be replaced in the next decade or two. Moreover, many drinking
water systems will have to make additional investments in treatment
equipment to satisfy forthcoming regulations under the Safe Drinking
Water Act. A future but growing investment need is for large
desalination plants in the South and West. In short, costs to
construct, operate, and maintain the nation's water infrastructure can
be expected to rise significantly in the near future.
The Problem with Current Law
While traditional methods for financing water and wastewater
facilities are available, the growing magnitude of the problem dictates
that public officials seek out a wider range of solutions including
financing tools that encourage private-public partnerships. These
partnerships allow the development of more cost-effective projects
using non-recourse financing while minimizing project risk to
taxpayers.
Unfortunately, under the current volume cap restrictions for PABs,
less politically attractive long-term water and wastewater
infrastructure needs are not being met. In most cases, states have
allocated only a small fraction of their volume cap to such
infrastructure needs, with the vast majority going to education and
housing. (See the Department of Treasury testimony chart entitled
``Figure 2: Uses of Private Activity Bonds, 1987-2003) In a number of
key states, such as California, no PABs have been authorized for water
and wastewater infrastructure in recent years. By discouraging
innovations in financing, current policy places a greater burden on
local, state and federal governments to provide direct funding for
infrastructure.
The volume cap on the use of PAB's forces states to make tough
choices concerning important infrastructure investments. Privately
owned facilities are most often short-changed in the decision-making
process because public officials choose to use their volume cap for
more short-term politically attractive activities. If privately owned
water facilities were removed from the cap, states could make more
rational decisions on providing public financing based on the need to
upgrade or modernize an infrastructure asset essential to future
economic development and health for its citizen.
If Congress takes the private activity bonds for water and
wastewater infrastructure outside the state volume cap, the financing
tool would unleash untapped resources to meet this emerging crisis.
Over the last two decades, policymakers were able to avert a similar
crisis in the solid waste management field by removing solid waste
facilities from the cap, resulting in the generation of over $20
billion in financing.
The cost of H.R. 1708 to the Federal Government is negligible;
according to the Congressional Joint Tax Committee, removing the volume
cap for water and wastewater projects will cost the government only
$187 million over ten years. That limited investment, however, could
leverage billions of dollars in much needed water project financing.
Some commentators have suggested that instead of removing the
volume cap for water and wastewater just raising the cap for all
qualifying bonds would suffice. Increasing the amount of the volume cap
has been helpful in certain states. But, it is not enough in most
situations. Many of the infrastructure projects in need of public-
private partnerships are huge, multi-year undertakings. From the
perspective of many states theses spikes in investment would often
absorb too large a commitment in any given year. Additionally, many
private sector investors are not willing to commit to multi-year
projects without some guarantee that future volume cap will be there
when they need it.
These same commentators point out that many states currently do not
use their entire volume cap and therefore question the need for
removing water and wastewater all together. In many instances, these
water projects are large enough to absorb most, if not all of a state's
cap. As discussed earlier, these types of projects include desalination
plants, solving storm water/sewerage overflow issues, and large scale
water main replacement needs. While a particular state may have some
small amounts of volume cap left over at the end of a particular year,
such an amount may not be large enough to address many of these
problems.
Conclusion
In sum, lifting the state volume cap for water and wastewater
infrastructure will result in lower cost financing that is passed on to
ratepayers, will encourage private sector partnerships to spread risk
and encourage innovation, and will relieve all levels of government
from the need to fund these much needed investments.
Statement of the National Council for Public-Private Partnerships
The National Council for Public-Private Partnerships (NCPPP) is a
non-profit, non-partisan educational organization founded in 1985 for
the purpose of providing a forum for the innovative ideas and best
practices for public-private partnerships. Members of the Council are
from both the public and private sectors. NCPPP wishes to respectfully
submit this testimony for the March 16 hearing by the Select Revenue
Subcommittee on HR 1708, the Clean Water Investment and Security Act,
to remove the cap on Private Activity Bonds (PABs) for water/wastewater
projects.
Private Activity Bonds (PABs) are an important tool in the
financing of critical water/wastewater infrastructure. However, current
federal tax law imposes caps on PABs for these projects despite the
dramatic needs of the nation for the construction and restoration of
its water infrastructure.
The ``unified volume cap'' that restricts the amount of PABs that
states and localities may issue in any given year hampers their ability
to address budget shortfalls in providing the public with critical
water infrastructure. While other activities have been exempt from such
caps, the alternative method for investment using PABs for water
related projects continues to be limited by current federal tax laws.
By removing the unified volume cap on PABs, communities can gain
access to more affordable interest rates as well as an important
financial tool to deal with substantial funding shortfalls for the
construction of critical water and wastewater treatment facilities.
Through the exemption of water infrastructure projects from the bond
cap, state and municipal governments would have greater flexibility and
additional options to partner with the private sector in the
developing, financing, owning and operating water and wastewater
infrastructure, should they choose to do so.
This is also a step towards enabling state and local governments to
obtain sustainable funding for the construction and operation of water
infrastructure on a full life-cycle basis. This is as opposed to the
limited and sometimes untimely availability of public program funds,
which has been anticipated to be over $11.4 billion dollars short in
the FY06 budget.
In summary, NCPPP encourages Congress to extend the list of tax-
exempt private activity bonds volume cap exemptions to include water
and wastewater projects as proposed in H.R. 1708.
Statement of the National Council of State Housing Agencies
Mr. Chairman, Representative McNulty, and members of the
Subcommittee, thank you for the opportunity to submit testimony on the
use of tax-preferred bond financing. The National Council of State
Housing Agencies (NCSHA) urges Congress to preserve and strengthen the
tax-exempt private activity housing bond (Housing Bond) programs in any
tax legislation it undertakes.
NCSHA provides this testimony on behalf of the housing finance
agencies (HFAs) of the 50 states, Puerto Rico, the U.S. Virgin Islands,
the District of Columbia, and the hundreds of thousands of lower-income
families these agencies house each year with the help of the Housing
Bond and Low Income Housing Tax Credit (Housing Credit) programs. HFAs
administer the Housing Credit and issue Housing Bonds in every state to
finance affordable ownership and rental housing in thousands of
communities nationwide.
The Housing Bond and Credit programs are by far the most effective
tools states have to respond to their enormous affordable housing
needs. With these programs, HFAs have provided millions of working
families affordable ownership and rental housing and improved the
quality of neighborhoods across the country.
NCSHA is deeply grateful to Congress for its steadfast support of
the Housing Bond and Credit programs. Just three months ago, Congress
recognized the value of these programs when it passed legislation
turning to them as crucial tools to assist in the recovery of the Gulf
Region from the devastation of Hurricanes Katrina, Rita, and Wilma.
Over 85 percent of the Congress, including most members of this
Subcommittee, cosponsored legislation enacted in 2000 to increase
Housing Bond and Credit authority by 50 percent and 40 percent,
respectively, and linking the authority to inflation.
NCSHA also recommends Congress make the already successful Housing
Bond and Credit programs work even better for America with a few
changes, many at low or no cost to the federal government, to make them
even more flexible and responsive to state housing needs. Specifically,
NCSHA urges you to pass H.R. 4873, sponsored by Representative Jim
Ramstad, which would strengthen the Housing Bond program by exempting
Housing Bond investments from the alternative minimum tax to attract
more investors and reach even lower-income families, exempting single
parents and families whose homes are destroyed by disaster from the
first-time homebuyer requirement, and allow HFAs to recycle more
resources by providing relief from the Mortgage Revenue Bond Ten-Year
Rule.
The Nation's Affordable Housing Crisis
America's need for affordable housing is great and growing. More
than 14 million working families of modest means in this country spend
at least 50 percent of their income on housing. Hundreds of thousands
more live in substandard housing or are homeless. Meanwhile, according
to a recent report from Harvard University's nationally renowned Joint
Center for Housing Studies, we are losing 200,000 affordable housing
units annually to conversion, disrepair, and abandonment, exceeding the
current rate of affordable housing production using existing resources,
such as the Housing Bond and Credit programs. The Center for Housing
Policy also has documented in a recent study that the homeownership
rate for working families with children has actually declined since
1978.
Federal funding for housing programs is insufficient to make
headway against this affordable housing crisis. Since 2001, the funding
for HUD programs as a percentage of total federal discretionary
spending has declined by 20 percent. Even the scarce housing resources
we have are in jeopardy. The Administration has proposed a 5 percent
inflation-adjusted cut in overall FY 2007 HUD discretionary funding,
including a $1.1 billion cut for Community Development Block Grant
programs, which often used in conjunction with Housing Bond and Credit
programs to create affordable housing. While the crucial funding for
housing programs has been declining, many Americans are left waiting
for help. Three quarters of those eligible for federal housing
assistance today do not receive it.
Creating Homeowners With Tax-Exempt Bonds
To help make homeownership affordable to working families each
year, the federal government allows state and local governments to use
tax-exempt single-family housing bonds, also known as Mortgage Revenue
Bonds (MRBs) to finance low-interest mortgages for lower-income first-
time homebuyers. MRBs have made first-time homeownership possible for
more than 3.5 million lower-income families--more than 100,000 every
year.
Congress limits MRB mortgages to first-time homebuyers who earn no
more than the greater of area or statewide median income. Larger
families can earn up to 115 percent of the greater of area or statewide
median income. In 2004, the average MRB homebuyer earned $41,431--less
than 60 percent of the national average family income. Congress also
limits the price of homes purchased with MRB mortgages to 90 percent of
the average area purchase price. The average purchase price of an MRB-
financed home was $118,561--less than 65 percent of the national median
home purchase price.
Investors purchase MRBs at low interest rates because the income
from them is tax-free. The interest savings made possible by the tax-
exemption is passed on to homebuyers by lowering their mortgage
interest rates.
Each state's annual issuance of Housing Bonds and other so-called
private activity bonds--including industrial development,
redevelopment, and student loan bonds--is capped. Congress in 2000
increased the private activity bond cap by 50 percent and indexed it to
inflation. The 2006 limit is $80 times state population, with a minimum
of $246,610,000.
Multifamily Bonds--An Effective Supplier of Affordable Rental Housing
In addition to the proven effectiveness of MRBs, HFAs also issue
multifamily Housing Bonds to provide financing for the acquisition,
construction, and rehabilitation of affordable rental housing for low-
income families. Multifamily Housing Bond-financed properties are
dedicated over the long term at restricted rents and must set aside at
least 40 percent of their apartments for families with incomes of 60
percent or less of median area income (AMI)--on average, families
earning $34,800 or less--or 20 percent of their apartments for families
with incomes of 50 percent or less of AMI.
The multifamily Housing Bond program has financed over 1.2 million
apartments to respond to the severe shortage of decent, safe, and
affordable housing for low-income families--working families, seniors,
people with disabilities, homeless families and individuals, and people
with special needs all across the country.
Multifamily Housing Bonds are often combined with Housing Credits
to provide affordable rental housing targeted more deeply to more low-
income families. More than 40 percent of apartments that receive
Housing Credits are financed with multifamily Housing Bonds. The
Housing Bond and Credit programs have financed over 2.7 million
apartments since 1986 and 160,000 apartments each year. Together, they
are the only significant producers of affordable rental housing.
Promoting Economic Growth and Job Creation
The Housing Bond programs are not just good for housing; they are
good for the economy. In 2004, the MRB program generated over 71,000
jobs, $921 million in wages and salaries, and over $1.7 billion in
government revenue, while 2004 multifamily Housing Bond issuance
generated nearly 68,000 jobs, $2.9 billion in wages and salaries, and
$1.6 billion in government revenue.
Impact of Tax Reform Proposals on Housing Bonds
Several tax reform proposals put forward by members of Congress and
the President's Advisory Panel on Federal Tax Reform would eliminate or
diminish the impact of the Housing Bond programs. As you consider these
proposals, NCSHA urges you to preserve the Housing Bond programs in any
tax reform legislation you undertake. If any of the damaging proposals
were to be enacted, the private market would not make up for these
losses.
The Housing Bond programs help finance affordable housing
production that would not otherwise occur. Land and other residential
development costs far outstrip inflation in many areas of the country.
The increased housing costs resulting from these increased land and
residential development expenses severely impact the ability of lower-
income families to meet monthly payments. Conventional mortgages are
not as affordable as MRB-financed mortgages. Average rents in the
unsubsidized rental housing market are far greater than rents of
apartments financed with multifamily Housing Bonds.
Importantly, direct spending programs cannot replicate what the
Housing Bond programs achieve through their private-sector discipline.
Housing Bond investors risk losing the primary economic benefit of
their investments (i.e., through the loss of the Bonds' tax-exempt
status) if the programs fail to achieve their public purposes. This
threat provides a performance incentive unmatched by direct spending
programs that has helped make the Housing Bond programs an effective
federal mechanism for providing affordable housing.
On the other hand, tax reform could greatly enhance the Housing
Bond programs by eliminating tax code provisions that inhibit their
effectiveness. For example, proposals to eliminate the Alternative
Minimum Tax (AMT), or at least exempt Housing Bonds from it, would
lower bond yields, increasing affordability.
Since 1986, the interest income on new money private activity
bonds, unlike general obligation and 501(c)(3) bonds, has not been
exempt from the AMT. As a result, demand for private activity bonds is
weakening. To the extent potential Housing Bond investors are or fear
becoming subject to the AMT, they either demand higher yields on the
Housing Bonds they buy, reducing the dollars available for housing, or
decline to buy Housing Bonds. Higher bond yields lead to higher
mortgage rates, decreasing affordability for lower-income homebuyers
and renters. AMT relief will lower bond yields and improve housing
affordability.
An Opportunity to Strengthen the Housing Bond Programs
NCSHA also calls on Congress to improve the Housing Bond and Credit
programs and make them even more responsive to today's affordable
housing needs in any tax legislation it undertakes. By enacting a
handful of changes--many at low or no cost to the federal government--
Congress could make these programs more effective and efficient. H.R.
4873 contains such program improvements.
In consultation with all state HFAs and every major national
housing industry group, NCSHA helped Representative Ramstad develop the
Housing Bond proposals in H.R. 4873. These include:
Exempting Housing Bond investments from the alternative
minimum tax (AMT) to attract more investors and reach even lower-income
families;
Exempting displaced homemakers, single parents, and
families whose homes are destroyed or made uninhabitable by
presidentially declared natural disasters from the MRB program's first-
time homebuyer requirement so HFAs will have greater flexibility to use
the MRB program to assist in disaster recovery and serve vulnerable
populations;
Providing relief from the MRB Ten-Year Rule so states can
recycle more MRB mortgage payments into new mortgages for first-time
homebuyers; and
Make technical changes to the Housing Bond programs to
simplify their administration and allow them to serve more populations,
such as homeless individuals.
We would be happy to provide the Subcommittee with more information
on the rationale for and details of these recommendations.
Thank you for your attention. NCSHA is available to assist you in
any way.
Statement of Steven Simons, Wellesley, Massachusetts
My name is Steven Simons. In 2004, I retired as a partner at Ropes
& Gray LLP, where I practiced municipal bond law for thirty years,
principally in the revenue bond area.
My statement reflects my own views and should not be considered to
be the views of Ropes & Gray or any lawyer now or at any time in the
past practicing law at Ropes & Gray.
I would like to address what I consider to be a substantial
inequity in the treatment of educational and cultural institutions
under IRC Section 145, which has led to the easier issuance of revenue
bonds for wealthy 501(c)(3) institutions, while not really addressing
the needs of less fortunate institutions. I believe that Congress
recognized this inequity in part when it imposed a $150 million
limitation on the issuance of non-hospital bonds, which in my view was
unfortunately repealed by the Tax Reform Act of 1986.
There are several factors that contribute to this inequity. First
is what I would refer to as the ``knowledge'' factor. The wealthier
501(c)(3) institutions not only know of the existence of tax-exempt
financing but they know how to ``play the game.'' With the assistance
of legal counsel and financial advisors, they are smart enough to adopt
an all-inclusive inducement resolution before spending any money on a
capital project so that they can make internal advances which can later
be reimbursed from bond proceeds. Additionally, and of more
significance, is the manner in which the issuance of tax-exempt debt
and contemporaneous capital campaigns is handled. Since tax-exempt debt
for a capital project cannot be issued if the institution has funds on
hand ``earmarked'' for that project (or the debt must be repaid when
the earmarked funds are received), the institution simply does away
with the concept of earmarking by soliciting pledges and accepting
gifts for unrestricted endowment instead of bricks and mortar. I have
personally seen examples of capital campaigns in which a particular
dollar amount is to be raised. Four or five specific capital
improvements were to be made (with estimated dollars next to each, or
better yet no reference to the cost of such improvements), together
with additional targets for financial aid for students, additional
money for faculty salaries and general endowment purposes (again with
or without specific dollar amounts). The fundraising literature will
note that large gifts for whatever purpose will be recognized by naming
rights, and the pledge cards do not specify which part of the campaign
is to be benefited from the gift. Frequently, donors have a particular
project in mind but are told that the ability of the institution to
issue tax-exempt debt is dependent upon the gift being unrestricted. On
occasion, I have been asked if pledges for a specific project
(generally, a building) can be rescinded. I have not permitted this
practice, although I am aware of other bond counsel that do. I have
even heard anecdotally of instances in which a restricted gift, prior
to its use, was changed to an unrestricted gift with the consent of the
donor.
The end result: the capital campaign is successful, tax-exempt
bonds are issued and debt service is paid from unrestricted endowment.
This works particularly well for institutions with large endowments
prior to the capital campaign, since the institution can argue that
even without the campaign, there would be enough money to pay debt
service on the bonds. (Of course, there might be barely enough money to
pay current expenses of the institution in addition to debt service,
let alone expenses five years down the road, including operating
expenses for the new facilities.) At a presentation by a financial
advisor for independent schools that I once attended, the principal
speaker described this situation as a way for borrowers to legally
``arbitrage'' funds, a pronouncement that still causes me to cringe.
Contrast this situation to a local YMCA or Boys and Girls Club that
wants to build a new facility. Since the capital campaign is for a
single purpose, the amount of tax-exempt debt issued must be redeemed
by funds already raised and further reduced as pledges are paid. Should
these institutions have added an endowment component to their capital
campaign, even though they did not intend to fundraise for endowment,
simply to place them on the same footing as the wealthier institutions
described above? I am concerned that these smaller institutions are
beginning to do just that and that this activity will haunt them in the
future if the bond issues are audited by the Service.
Additionally, consider some additional differences between a tax-
exempt bond issue for WG University (``WGU''), with an endowment of
more than $1 billion, and the PoorFolks Boys and Girls Club
(``PoorFolks''), with a minimal endowment and a much smaller bond
issue. First, consider, the source of financing. Many national
underwriters would not consider either a public offering or a private
placement of tax-exempt debt of an amount under $40 million. This is no
problem for WGU, which wishes to raise $250 million (and whose prestige
will rub off on the underwriter. However, a $2 million bond issue for
PoorFolks will likely have to be sold to a local bank which, because it
cannot deduct the cost of purchasing or carrying tax-exempt debt, is
offering a considerably higher interest rate and a shorter term for
PoorFolks' bonds than WGU is receiving. Sure, WGU is on a much sounder
financial footing and a combination of its financial condition and its
reputation will certainly generate a lower overall interest rate. But
if its financial condition and reputation is so good, why is the
federal government subsidizing its debt?
Second, the wealthier the institution, the fewer financial
covenants are required. WGU may issue substantial amounts of tax-exempt
debt with no (or few) covenants and with no underlying security. The
bank purchasing the PoorFolks bonds may insist upon a lien upon the
borrower's entire campus and stringent covenants, including financial
covenants that, directly or indirectly, will require the institution to
maintain a sufficient amount of money on hand to ensure that there will
be some money available to pay debt service. I am constantly astonished
that the Internal Revenue Service has not issued a letter ruling or
made another pronouncement that such arrangements create impermissible
replacement proceeds. I am also somewhat dismayed that many
transactions for the neediest institutions will not go through without
such covenants, giving wealthier institutions a distinct advantage in
issuing tax-exempt debt.
In between WGU and PoorFolks, we may have bond issues in the range
of $20 million to $40 million, which are underwritten or privately
placed with a bond fund by a regional underwriter and supported by a
letter of credit. (This approach appears to be common now in financings
for independent secondary schools.) PrepSchool may wish to build a new
gymnasium or classroom complex. It is savvy enough to structure a
contemporaneous capital campaign that avoids ``earmarking.'' Depending
on its PrepSchool's financial condition, the issuer of the loc may
require the type of covenants that a bank would require of Poorfolks
(again raising the spectre of replacement proceeds) and either a lien
or a negative pledge of the borrower's campus.
At the end of the day, what do we have? Inexpensive, trouble-free
borrowing by wealthy institutions and expensive, cumbersome borrowing
by its less wealthy cousins. It doesn't take a rocket scientist to see
who is getting the benefit of the revenue loss to the federal
government. In an era of scarce resources and burgeoning deficits, is
this really the most efficient method of assisting those non-profit
entities that need the interest rate subsidy the most? I think not, and
I urge the Committee to address the inequity here.
Thank you.
Smith & Loveless, Inc.
Lenexa, Kansas 66215
March 23, 2006
The Honorable Bill Thomas
Chairman
Committee on Ways and Means
U. S. House of Representatives
Washington, D.C. 20515
Dear Chairman Thomas:
We here at Smith & Loveless, Inc. and its affiliated companies, are
very supportive of H.R. 1708, the Clean Water Investment and
Infrastructure Security Act. We have been supplying equipment and
services to the water and wastewater market for sixty years. We employ
on a direct basis more than 400 employees from PHD's and graduate
environmental, civil, mechanical, chemical, electrical, and industrial
engineers to highly qualified unionized personnel, as well as a full
compliment of support personnel.
I personally have been involved in this industry for more than
forty years and had the pleasure of representing our industry as
Chairman of the Water & Wastewater Equipment Manufacturers Association.
I currently chair the Presidents Council, made up of the leading
manufacturers in this industry representing thousands of employees and
several billion dollars of taxable revenues.
We are very aware of the nation's needs in regards to the
environmental sector and we are all keenly aware of the shortfall of
available funds to meet the nation's infrastructure needs. The funds
needed are mind-boggling and we recognize that this shortfall cannot be
made up by Grants from the Federal Government, or State and local
funding. User fees would have to be increased to a level that would
seriously impact those who least can afford them as well as have a
serious effect on inflation and our ability as a country to compete.
We as a nation are becoming more and more aware of the need to
upgrade our environment to safeguard our health and those of future
generations. It is one thing to mandate higher standards and another
thing to actually get them in place. The funding question is paramount.
No constituent wants to pay higher taxes, as well as very few
politicians want to raise taxes. We know that taxes remove from the
economy the options that create our GNP.
That is why I believe the approach taken by H. R. 1708 is a very
sound approach. While the bonds issued will be for the most part tax
exempt, they will not effect the Federal Deficit, as would a grants
program. The funding will be generated from the private sector. The
equipment and services generated by the bonds will create thousands of
high-paying construction and manufacturing jobs. All of which will give
a return at the Federal level in the form of taxes and increased GNP.
In addition, the profits of the companies supplying the equipment and
services will further enhance the Federal and State treasuries. Another
benefit of this program will be by upgrading the health of the
environment and lowering in current and future generation the cost of
health care. How much is that worth?
H. R. 1708 is a win win situation. We support this bill without
equivocation.
Sincerely,
Robert L. Rebori
Chairman and CEO
Statement of the U.S. Conference of Mayors and the Urban Water Council
Chairman Camp, Ranking Member McNulty and Members of the
Subcommittee, The United States Conference of Mayors (USCM) appreciates
this opportunity to express our support for H.R. 1708 introduced by
Representatives E. Clay Shaw and Jim Davis. H.R. 1708 is a bill that
would strengthen the intergovernmental partnership and provide a much
needed boost to local government investment in public-purpose water and
sewer infrastructure in America.
A 2005 Survey conducted by the Conference of Mayors revealed that
rehabilitating the aging water infrastructure is the highest water
resource priority of the nation's principal cities. While local
government is committed to sustaining major capital investment in water
and wastewater infrastructure it has become clear that the $500 billion
plus ``Needs Gap'' in investment needed to comply with the unfunded
mandates imposed by the Clean Water and Drinking Water laws will not be
closed. The need for capital investment is so great that traditional
use of tax-exempt municipal bonds (revenue bonds and general obligation
bonds), public water and sewer user fees and charges and Federal low
interest loan programs combined will have the effect of helping cities
run-in-place, but not make substantial progress in closing the ``Needs
Gap.''
Cities will continue to use these financing tools to rehabilitate
and expand public-purpose water and sewer infrastructure, but they are
also implementing greater levels of asset management expertise and the
use of Public-Private Partnerships to control or reduce costs for
operations and maintenance as well as construction and reconstruction.
Cities continue to seek ways to maximize public benefits in the most
cost-efficient ways.
The Conference of Mayors adopted policy in support of changing the
tax code to eliminate state caps on private activity bonds for public-
purpose water and sewer infrastructure investment. It is painfully
clear that increasing user rates, and the continued use of tax-
preferred bonds and low interest loan programs, combined, are necessary
but insufficient to satisfy the investment needs to comply with Federal
and state law. Hence, it makes good economic and quality of life sense
to turn to private sources of capital through the increased use of
private activity bonds. Local government has the ability to harness
private capital for public benefit by using private activity bonds to
fund water and wastewater infrastructure development, as the Shaw-Davis
bill would allow. While the caps stay in place the use of these tax-
preferred instruments are limited due to competition for investment in
other worthy public benefit programs. By eliminating the state volume
caps for this limited purpose the Federal tax code would help rather
than hinder local government efforts to meet Federal environmental and
public health mandates.
Concern was expressed at the March 16, 2006 Ways and Means
Subcommittee on Select Revenue Measures Hearing by the Witness from the
U.S. Department of the Treasury that the use of tax-preferred bonds be
properly targeted, and ensure that the Federal subsidy is justified.
The U.S. Conference of Mayors shares these concerns. The use of tax-
preferred bonds as an incentive to finance public-purpose
infrastructure and projects should meet the critical litmus test of
broad public benefit. The use of private activity bonds for public-
purpose water and sewer infrastructure projects provides an excellent
example of how both of the concerns expressed by Treasury are
satisfied.
A fundamental underpinning of Congressional adoption of the Clean
Water Act was that it would provide broad public benefits to the
American people by improving and protecting the quality of interstate
waters. Despite vast improvements in public sanitation in the early to
mid-1900s through the development of modern sewage collection
infrastructure public health was adversely impacted by the direct and
untreated or under-treated discharge of sewage into the very rivers and
water bodies that were used for drinking water supplies. Congress
established the publicly-owned sewage treatment works (POTW)
construction grant program specifically to protect the public health of
the American public from polluted interstate waters. While the
construction grants program has been abolished, the public health
threat remains very much alive.
Congress reconfirmed their commitment to help protect the
interstate waters and public health by replacing the construction grant
program with the Clean Water State Revolving Fund loan program (CWSRF)
in the late 1980s, and establishing the Safe Drinking Water State
Revolving Fund loan program (SDWSRF) in the 1990s. This policy shift
signaled the recognition that local government still required financial
assistance to help protect the integrity of the nation's interstate
waters and public health; and the recognition that the cost to
accomplish this goal was so great that the Federal government could no
longer afford grants but would employ financial incentives through low
interest loans, and continue to allow the use of tax-preferred bonds
for this purpose.
It is important to point out that the benefit to the American
people from investment in clean and safe water is not limited to
protecting public health. Clean water policies help to protect natural
species as well. Further, the provision of a clean, safe and reliable
water supply creates certainty in our markets and our institutions, and
that is a prerequisite for local and regional economic health. While
there is much left to be done to close the water infrastructure ``Needs
Gap,'' the historical and current level of water infrastructure
investment in America is one of the distinguishing characteristics of
our nation. It is one of the reasons why we continue to have a strong
economy and stay globally competitive. The Federal government should
expand the use of tax incentives to sustain our public health, strong
economy and natural resources.
______
The United States Conference of Mayors
The U.S. Conference of Mayors is the official nonpartisan
organization of cities with populations of 30,000 or more. There are
approximately 1,200 such cities in the country today. Each city is
represented in the Conference by its chief elected official, the mayor.
The primary roles of the Conference of Mayors are to:
Promote the development of effective national urban/
suburban policy;
Strengthen federal-city relationships;
Ensure that federal policy meets urban needs;
Provide mayors with leadership and management tools;
and Create a forum in which mayors can share ideas and
information.
______
Urban Water Council
The Urban Water Council (UWC) is a Task Force of The U.S.
Conference of Mayors (USCM). The UWC is open to all Mayors, and
provides Mayors with a forum for discussion of issues impacting how
cities provide and protect water and wastewater services to the
community. Some of the issues that the UWC focuses on include:
watershed management; water supply planning; water infrastructure
financing; rehabilitation of surface and sub-surface water
infrastructure; water conservation; wetlands construction and education
programs; water system program management and asset management; etc.
The UWC develops local government positions on Federal legislation,
regulations and policy. The UWC acts through the USCM Environment
Committee, and other Committees, as appropriate, to propose and adopt
resolutions on water related matters that benefits the nation's
principal cities.
The U.S. Conference of Mayors
Resolution Adopted in Boston
June 2004
INCREASING INVESTMENT FOR WATER AND WASTEWATER INFRASTRUCTURE THROUGH
REMOVAL OF PRIVATE ACTIVITY BONDS FROM THE STATE VOLUME CAP
WHEREAS, the projected costs for capital improvement and projects
in water and wastewater infrastructure are projected to exceed $1
trillion over the next 20 years in order to comply with the Clean Water
Act and the Safe Drinking Water Act; and
WHEREAS, the U.S. Conference of Mayors adopted policy in the year
2000 in Seattle to seek out innovative ways to help cities finance the
construction of new water and wastewater treatment facilities,
collection systems and distribution systems; and
WHEREAS, the Urban Water Council has reviewed federal impediments
to financing water and wastewater infrastructure including existing
environmental and tax policy, and
WHEREAS, the Urban Water Council adopted a resolution to support
similar legislation in June of 2001 that would exempt Private Activity
Bonds for water and sewage facilities from the state volume caps, but
that legislation is no longer under consideration by congress, and
NOW, THEREFORE, BE IT RESOLVED that The U.S. Conference of Mayors
hereby endorses and urges Members of Congress to support legislation
which would exempt Private Activity Bonds for water and sewage
facilities from the state volume caps in order to increase investment
in water and wastewater supply infrastructure.
Statement of the Water and Wastewater Equipment Manufacturers
Association
On behalf of the nation's producers of water and wastewater
technologies used in municipal and industrial applications, worldwide,
the Water and Wastewater Equipment Manufacturers Association (WWEMA) is
pleased to present its views on H.R. 1708, the ``Clean Water Investment
and Infrastructure Security Act.'' Our organization considers this
legislative proposal to be of utmost importance in helping to finance
the nearly $1 trillion in needs facing our nation's water and
wastewater infrastructure over the next 20 years.
As stated, the purpose of H.R. 1708 would be ``to provide
alternative financing for long-term infrastructure capital investment
that is currently not being met by existing investment programs, and to
restore the Nation's safe drinking water and wastewater infrastructure
capability and protect the health of our citizens.'' It would do this
by removing public-purpose water and wastewater facilities from the
state volume caps on private activity bonds (PABs).
Due to their `hidden' nature, water and wastewater facilities have
been unable to compete to date under the state volume caps with the
more politically-attractive, high-profile housing, health and
educational facilities that receive the majority of PABs. Only 1% of
tax-exempt bonds have been issued for water projects since 1986. The
time has come to remove pubic-purpose water and wastewater facilities
from these state volume caps and unleash the full potential of private
sector capital to help communities meet their critical water
infrastructure needs.
It would be difficult to find a more worthy use for PABs today than
to invest in our nation's water and wastewater infrastructure. As was
the case in the 1990s when the country faced a solid waste crisis and
PABs were effectively used to stimulate private sector investment in
that sector, today we face an even greater crisis with the need to
repair, rehabilitate and replace our deteriorating water and wastewater
infrastructure now in order to stave off a national public health
epidemic in the not-too-distant future.
For various reasons, including a past reliance on the federal
government to subsidize water and wastewater infrastructure projects,
our industry has failed to charge the true cost of providing water and
sewerage services and maintain sufficient reserves to meet future
capital investment needs. This has led to an untenable funding gap.
Though user fees are now on the increase, it will take time to build up
sufficient capital reserves to meet future needs. We cannot afford to
further postpone needed investments in our nation's water
infrastructure. H.R. 1708 will leverage private capital to close the
funding shortfall.
By partnering with the private sector, communities throughout the
country will be able to avoid dramatic rate increases by having access
to low-cost financing, while benefiting from the efficiencies and
innovations commonly associated with private sector involvement in
public works projects. The private sector already plays a pivotal role
in providing services to the water and wastewater industry by operating
over 2,400 municipally-owned water utilities. H.R. 1708 will provide an
invaluable tool by encouraging private sector investment in water and
wastewater projects.
Conservatively, $1 to $2 billion in new funds could be invested
annually in the nation's water and wastewater infrastructure as a
result of this legislation. The nominal loss in tax revenue to the
federal government will be more than compensated by the billions in
taxes generated from the jobs that will be created and the products
that will be procured as a result of the infusion of additional capital
into the marketplace.
While others may call for a new massive federal grants program to
revitalize the nation's critical water infrastructure, during this
period of constrained federal spending, lifting the current state
volume caps on PABs for public-purpose water and wastewater facilities
is the least expensive option for addressing a growing national crisis
and ensuring that all Americans are guaranteed a safe, reliable water
infrastructure system. We urge Congress to move expeditiously on this
proposal.
The Water and Wastewater Equipment Manufacturers Association is a
Washington, D.C.-based, non-profit trade organization founded in 1908
to represent the interests of companies that manufacture and provide
water and wastewater product and services to municipal and industrial
clients, worldwide. Its member companies employ over 50,000 individuals
and generate in excess of $3 billion in sales globally.
Statement of the Water Partnership Council
Chairman Camp, Ranking Member McNulty, Members of the Committee:
The Water Partnership Council is pleased to provide this statement
for the hearing record in support of legislation to eliminate the
volume cap on tax-exempt private activity bonds for financing water and
wastewater improvements.
Communities, municipalities, water management districts, river
authorities, and water districts nationwide are confronted with the
need to replace and maintain outdated infrastructure and provide
service to additional customers. Nationwide, industry assesses these
needs for water and wastewater at $23 billion annually. Meeting this
infrastructure challenge requires the participation of all levels of
government and the private sector. Alternative management measures such
as public-private partnerships can provide communities with greater
flexibility in performing needed repairs and maintenance to their
systems. Public-private partnerships draw on the unique strengths of
both the public and private sectors, ensure a business-like approach to
asset management, and provide effective risk management.
A significant impediment to broader use of public-private
partnerships is the severely limited availability of tax-exempt
financing for partnerships. Currently, the tax code imposes a volume
cap on the amount of bonds that may be issued to finance capital
improvements to systems undertaken by the private partner. Many
interests compete under the volume cap for the limited amount of tax-
exempt financing in each state, and the allocation of these funds is
determined annually. Both of these factors contribute to uncertainty of
the availability of private bond funding for multi-year water and
wastewater infrastructure projects.
In 2001, the United States Environmental Protection Agency's
Environmental Financial Advisory Board recommended that private
activity bonds for water and wastewater facilities be exempted from the
state volume caps to allow more communities to more aggressively pursue
projects that reduce capital and operating costs. HR 1708, introduced
by Representatives Clay Shaw and Jim Davis, would do just that,
eliminating the need for communities that are engaged in public-private
partnerships to pick and choose between financing much-needed water
infrastructure and other activities eligible for private activity
bonding.
The Water Partnership Council strongly supports HR 1708 and urges
the Committee to act promptly to ensure this much-needed legislation is
enacted.
The WPC is a non-profit organization established by the leading
providers of operational services for water and wastewater systems in
the United States. The Council seeks to partner with citizens, local
governments, and organizations committed to strengthening this
country's water and wastewater infrastructure. Council members are
American Water, OMI, Inc., Severn Trent Services, Southwest Water
Company Services Group, United Water and Veolia Water North America.
For more information about the Water Partnership Council, please
call (202) 466-5445 or visit www.waterpartnership.org.