[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














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                      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.
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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.

                                  
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