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NLC urges enactment of long-term municipal financing initiative.

NLC and eleven other members of the Public Finance Network joined forces last week in testimony before the House Ways and Means Subcommittee on Select Revenue Measures, chaired by Rep. Charles Rangel (D-N.Y.), in support of the development of long-term capital finance legislation to assist states and local governments in meeting capital needs. The action came as Congress began consideration of whether to act on a second tax bill or not this year, and, if so, what changes to make in municipal authority to issue tax-exempt municipal bonds.

Aurel Arndt, general manager of the Lehigh County Authority in Allentown, Pa., testified on behalf of the coalition, urging Congress to advance the President's program for infrastracture investment, reinventing government, and job growth. The major issues NLC urged the Congress to address included:

* to modify the definition of public-purpose bonds;

* to substantially modify the arbitrage rebate requirement;

* to modify the bank interest deduction; and

* to index state volume caps.

Financing Cleanup of Contaminated City Sites

During the hearing House Ways and Means Committee Chairman Dan Rostenkowski (D.Ill.) came in to introduce his mayor, Chicago Mayor Richard Daley, and to announce his support for HR2340, legislation to provide tax credits and municipal tax-exempt financing to clean up and redevelop contaminated industrial sites. Rostenskowski said the bill may provide the answer to a key problem of inner city redevelopment by offering incentives for the private sector to prepare such sites for industrial and commercial use.

Mayor Daley testified that under current laws, businesses are often unwilling to buy used industrial properties in cities because of the potential enormous environmental liability. Remedial costs and liability are usually too much for cities to bear alone.

The proposal would create a pilot program available to four large, 20 medium and small sized cities, and rural areas in up to five states based on manufacturing job losses between 1970 and 1990, local commitment in fixing up contaminated industrial sites, and the city's share of contaminated sites as measured under the federal Superfund information systems list.

Public Purpose Bonds

Arndt told the committee that current federal tax law impedes the financing of true governmental projects, inappropriately classifies some publicly owned and operated facilities as "private activities," and prohibits financings in which appropriate private use of the facilities being financed materially assist in the efficiency of providing public services.

The state and local coalition recommended that Congress modify the present law definition of "governmental" bonds to provide that all facilities that are governmentally owned and operated be eligible be financed with tax-exempt "governmental" bonds and provide that the use of such facilities by a private entity not affect the qualification of bonds issued for the facilities as "governmental" if such use is pursuant to contractual or other arrangements that retain the essential governmental control of the facility.

Under present law private-activity bonds are securities issued by state and local governments where more than 10 percent of the facility being financed by the bonds is for a business use (business use test) and more than 10 percent of the debt service on the bonds is derived from payments from private users (security interest test). In general, private-activity bonds are taxable, but the federal tax code enumerates which private-activity bonds are eligible for tax exemption.

Under present law, private use of a facility arises from any of the following arrangements with a private entity: (1) a lease, (2) an output purchase contract, and (3) certain management and operating contracts. If the extent of private involvement exceeds both the business use test and the security interest test limits, the bonds issued to finance the facility will be classified as private-activity bonds and may be eligible for tax-exempt financing. Under present law, only certain so-called "exempt activities" are eligible for tax-exempt financing as private-activity bonds.

Arndt said the proposed NLC change would eliminate a serious flaw in the tax law that sweeps into the private-activity bond category those bonds issued to finance facilities whose cost is charged to users in the form of rents and other user charges. Some examples of the problems created by the present law are:

* government-owned space on the bottom floor of a government office building leased to a non-profit, federal, or private tenant that exceeded 10 percent of the total available space in the building;

* bonds to finance the expansion of the public sewer system where one occupant of an trial park in the city will be 11 percent of the extension's capacity and pays an amount equal to 11 percent of the service on the bonds;

* bonds to finance a new airport terminal owned and operated by a governmental authority, but secured by lease payments made by the airlines using the terminal facility.

Arndt testified that the changes were important to promoting public-private partnerships in the provision of government services, providing a more consistent approach in the application of the tax law with respect to eligibility for tax-exempt financing and the applicability of certain restrictions such as the volume cap; and permitting governments to enter into longer-term management contracts thereby reducing the costs of these facilities.

Arbitrage Relief

The coalition told Congress that repeal or substantial simplification of the arbitrage rebate requirement would greatly improve and streamline municipal finance and save cities and towns billions of dollars in compliance costs and additional borrowing costs that could be used for other new investments.

Unless a city is eligible for an exemption from the federal requirement to rebate arbitrage, or interest earnings on the priciple it holds from the sale of municipal bonds, to the federal government, the city must pay 100 percent of any excess arbitrage earned to the federal government. Rebatable arbitrage is the amount of investment earnings earned in excess of bond yield. This change, enacted in 1986, has forced municipalities trying to finance traditional governmental purposes (e.g., schools, roads, public utilities, public health, courts, jails, etc.) to syphon off investments of bond proceeds to pay a new tax to the federal government instead of paying for the governmental purposes for which the bonds were issued. The rebate requirement increases the amount of borrowing by cities and towns and reduces the amount of money available for these traditional governmental purposes.

Bank Deductibility

In 1986, Congress also changed the law to remove the deduction available to banks for the purchase of municipal bonds and notes, leading to the sale of nearly $200 billion worth of bank investments in municipal infrastructure and long and short term financing. In 1985, banks held 35 percent of outstanding municipal debt. At the end of 1992, this percentage fell to eight percent.

The coalition urged support for legislation submitted by Rep. John Lewis (D-Ga.), HR 2171, to increase the bank interest deduction exception annual limit from $10 million to $25 million. According to Arndt, by increasing the small city deduction, more cities would be eligible for lower-cost financing.

Volume Caps

The coalition urged Congress to modify the current strict limit or state volume cap to index it to inflation. In recent years, volume cap limitations have precluded the financing of necessary and worthwhile projects in many states. Currently private-activity tax-exempt bonds are subject to statewide volume caps equal to $50 per capita or $150 million, whichever is greater.

In 1986, statewide volume caps were set at the greater of $75 per capita or $250 million. Beginning in 1988, however, the caps were lowered to the current limits. This reduction was based on the incorrect assumption that municipal authority to issue Mortgage Revenue Bonds (MRBs) and Small-Issue Industry Development Bonds (IDBs) would expire at the end of 1987.
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Title Annotation:National League of Cities
Author:Shafroth, Frank
Publication:Nation's Cities Weekly
Date:Jul 19, 1993
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