[Congressional Record Volume 141, Number 24 (Tuesday, February 7, 1995)]
[Extensions of Remarks]
[Page E289]
From the Congressional Record Online through the Government Publishing Office [www.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

                        Tuesday, February 7, 1995
  Mr. CARDIN. Mr. Speaker, today I am introducing, along with my Ways 
and Means Committee colleague, Representative Clay Shaw, legislation to 
repeal a provision of the 1993 tax bill that has reduced secondary 
market liquidity for municipal bonds and complicated the Tax Code 
unnecessarily. The existing law will likely make 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. As a result of this provision, 
State and local issuers attempting to address America's chronically 
underfunded 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 in 1993 by the Budget Act.
  In certain situations, holders of municipal bonds seek to sell their 
securities at what is known as a market discount. Market discount is 
the difference between the purchase price of a bond and its stated 
redemption price at maturity. 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. Market discount is typically caused by a rise 
in market interest rates or a decline in the creditworthiness of the 
borrower.
  Before the enactment of the 1993 budget reconciliation bill, accreted 
market discount on a municipal bond was taxed as capital gain at the 
time the bond was sold, redeemed, or otherwise disposed of. A strong 
public policy argument can be made that, consistent with the tax 
exemption on municipal bond interest, market discount on State and 
local government securities should be exempt from taxation altogether.
  However, the legislation Congressman Shaw and I have
   introduced today seeks only to restore the traditional capital gains 
treatment of market discount bonds. We believe that increases in the 
value of market discount bonds should be treated as capital gains, 
consistent with the standard treatment of increases in the value of 
most investments.

  Under the new law, however, 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.
  Furthermore, 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. With the 
repeated rises in interest rates over the past year, the 1993 change 
has had dramatic consequences for the secondary market in these bonds.
  The change to ordinary income tax treatment for market discount bonds 
also reduces their liquidity because investors cannot 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 the securities will be more difficult to sell.
  The bottom line on the higher tax rates for market discount is that 
State and local governments 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 as much as 25 basis points higher than they would 
have been under the old rules. These effects have been exacerbated over 
the past year as interest rates have risen and bond prices have fallen.
  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.
  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. As Federal and State 
budgets get tighter and tighter, the importance of the tax-exempt 
market increases. For those reasons, I propose that Congress restore 
the law to its pre-1993 status.
  The current proposal to cut the capital gains tax presents us with an 
opportunity to address this important issue. Consistent with that 
effort to encourage investment, we should reverse the destructive 
proposal enacted in 1993, and remove the penalty on investors and 
issuers it imposed. I encourage my colleagues to join me as cosponsors 
of this legislation.


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