Lobbying for flexibility in tax-exempt financing: GFOA and the Public Finance Network are working to introduce a bill in Congress that will ease some of the restrictions on the use of tax-exempt municipal bonds.(Federal Focus)

The Center for Budget and Policy Priorities recently projected the nation's 10-year budget deficit, beginning in 2004, to be near $5.1 trillion. (1) This estimate includes a Medicare prescription drug benefit, the cost of the war in Iraq, making permanent the 2001 and 2003 tax cuts, and alternative minimum tax relief. The Congressional Budget Office, which now estimates the 10-year budget deficit at $1.4 billion, did not include such initiatives in its estimate. (2) The deficit picture is further clouded by the spending increases that will be needed for the Medicare and Social Security programs when the baby boomers begin to reach retirement age in 2012.

As noted in the August installment of the Federal Focus (and in Christopher Hoene and Michael Pagano's article in this issue), the intense pressures on the federal budget are having a negative impact on essential programs at the state and local levels. While GFOA and the other local and state government organizations that comprise the Public Finance Network continue to push for additional funding through the federal appropriations process, the group is also looking for legislative remedies to the fiscal challenges facing state and local governments.

One way the federal government could greatly assist state and local governments, universities, non-profit health care facilities, public power entities, and housing authorities to allow for greater flexibility in the use of tax-exempt bonds. Many of the laws pertaining to the issuance of tax-exempt bonds have not been updated since the Tax Reform Act of 1986 and the Technical and Miscellaneous Revenue Act of 1988. So while the fiscal needs of state and local governments have evolved through the years, the laws governing public finance are effectively stuck in place, circa 1986.

The members of the Public Finance Network have been lobbying for changes to these laws almost since their inception. Topping the list of changes the PFN would like to see included in a public finance bill to be introduced in Congress are the following:

Relax federal arbitrage rules. Two areas in particular require remedy. First, the small issuer exemption should be raised from $5 million to $25 million. Second, extending the spend-down exception from two years to three years is a simple, sensible approach to this perennial problem faced by issuers of all types of tax-exempt bonds. In addition, the National Association of Bond Lawyers has proposed a number of other helpful technical changes that it has brought to the attention of Congress and the Department of the Treasury. (3)

Increase the deduction threshold for bank-qualified bonds from $10 million to $25 million. Prior to 1986, banks were permitted to deduct all or a major portion of the costs they incurred to invest in municipal bonds. The 1986 Tax Reform Act eliminated this deduction except for certain "small issuers." This exception permits banks to deduct 80 percent of the costs of purchasing and carrying the bonds of municipalities that issue less than $10 million annually. However, this exemption is largely meaningless for many small issuers, since inflationary pressures have pushed their capital needs beyond $10 million (accounting for the rate of inflation, $10 million in 1986 equals $16.8 million today). In order to qualify for the exemption and remain attractive to institutional investors, small issuers are often forced to defer needed projects until a subsequent calendar year. The Independent Community Bankers of America supports this proposal.

Allow an additional advance refunding. Since 1986, governments have been permitted to advance refund tax-exempt bonds once over the lifetime of the debt. However, with interest rates still hovering around historically low levels and governments looking to free up resources any way they can, another advance refunding would be very beneficial. Earlier this year, Senators Gordon ...