[Congressional Record Volume 140, Number 86 (Thursday, June 30, 1994)]
[Extensions of Remarks]
[Page E]
From the Congressional Record Online through the Government Printing Office [www.gpo.gov]


[Congressional Record: June 30, 1994]
From the Congressional Record Online via GPO Access [wais.access.gpo.gov]

 
A BILL TO REVISE THE TAX TREATMENT OF MUNICIPAL SECURITIES PURCHASED AT 
                            MARKET DISCOUNT

                                 ______


                        HON. BENJAMIN L. CARDIN

                              of maryland

                    in the house of representatives

                        Thursday, June 30, 1994

  Mr. CARDIN. Mr. Speaker, today I am introducing legislation to repeal 
a provision of last year's tax legislation that has reduced secondary 
market liquidity for municipal bonds and complicated the Tax Code 
unnecessarily. The existing law may also have the effect of making it 
more difficult for States and localities to invest in our Nation's 
crumbling infrastructure.
  The provision in question changed the way certain municipal bonds are 
treated under the Internal Revenue Code and caused some of these bonds 
to be less attractive to investors. State and local issuers attempting 
to address America's chronic public investment needs may be forced to 
offer higher yields on their securities, which would drive up their 
borrowing costs.
  Of critical importance to the success of the American system of 
public finance is the liquidity of the secondary market for municipal 
bonds. Investors are willing to accept lower rates of return on State 
and local government securities because of the tax exemption, but also 
because they know they can readily sell their bonds, if necessary, 
before maturity. It is this indispensable characteristic of the 
municipal bond market that was handicapped last year by the Budget Act.
  In certain situations, holders of municipal bonds seek to sell their 
securities at what is known as a market discount. In general, market 
discount occurs when a bond is purchased on the secondary market at a 
price below par or below the adjusted issue price, and is typically 
caused by a rise in market interest rates or a decline in the credit-
worthiness of the borrower. Market discount is the difference between 
the purchase price of a bond and its stated redemption price at 
maturity.
  Before the enactment of last year's budget reconciliation bill, 
accreted market discount on a municpal bond was taxed as capital gain 
at the time the bond was sold, redeemed or otherwise disposed of. Under 
the new law, accreted market discount is taxed as ordinary income.
  Since they are now subject to higher ordinary income tax rates, 
market discount bonds have become more difficult to sell on the 
secondary market than other municipal bonds. Any security issued by a 
State or locality could become a market discount bond at some point 
during its life, so secondary market liquidity for all municipal 
securities has decreased. Also decreasing demand for market discount 
bonds is the fact that investors can no longer use capital gains on 
market discount bonds to offset capital losses. Investors in secondary 
market municipal securities now demand higher rates of return to 
compensate them for higher tax rates on discount bonds and for 
increased risk that their securities will be more difficult to sell. 
These higher rates mean that States and localities could ultimately 
face higher costs in issuing securities to pay for much-needed public 
infrastructure investment. Early anecdotal evidence suggests that 
yields on market discount bonds are 5 to 10 basis points higher than 
they would have been under the old rules.
  Moreover, the new market discount rule has resulted in a reporting 
nightmare for bond dealers, mutual funds, bank trust funds, and others 
who are required to sort out and document income to taxpayers. Some 
tax-exempt mutual funds have simply stopped buying market discount 
bonds altogether because of this complexity, further reducing the 
liquidity of and demand for these securities and driving up their 
yields.
  Since the new market discount rules could result in higher capital 
costs for state and local municipal bond issuers, raise extremely 
complex financial considerations that repel investors, and provide 
little or no economic advantage to the Federal Government, I propose 
that Congress restore the law to its pre-1993 status. Such a revision 
would be consistent with efforts to simplify the Internal Revenue Code 
under any comprehensive tax simplification measure. I encourage my 
colleagues to join me as cosponsors of this legislation.

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