U.S. Treasury Secretary Robert Rubin on April 15 announced a number of tax simplification proposals that the Administration plans to send to Capitol Hill next month.
The legislative package includes a NACo-supported measure to exempt certain government bonds from the payment of arbitrage earnings.
The exemption, or "safe harbor" proposal, was developed by NACo and the Government Finance Officers Association (GFOA) and is now supported by the National League of Cities, U.S. Conference of Mayors, National Governors' Association, National Conference of State Legislatures, and about a dozen other state and local organizations.
Arbitrage refers to the interest income (or profit) that issuers of tax-exempt bonds may be able to earn by investing the proceeds in higher yielding securities. Typically bonds are issued for the total estimated cost of a project and are expended as needed.
Federal arbitrage restrictions are complex, complicated and costly to counties, states and cities in terms of arbitrage rebate payments and compliance with current laws and regulations.
While counties and other issuers pay for lawyers, consultants, accountants and staff to comply, most issuers do not owe any rebate.
According to a recent U.S. Treasury analysis, less than 1,000 out of 27,000 1989 debt issues paid a rebate when the first payments were due in 1994 (as a general rule, rebate payments are due every five years). Approximately one-third of these rebates were paid by school districts and 86 issuers paid almost 50 percent of the $388 million collected that year.
The NACo-GFOA safe harbor proposal seeks to provide regulatory relief for the thousands of issuers that do not owe a rebate but pay significant compliance costs.
One way to provide meaningful simplification is to change the process so that prior to the sale of a bond issue, it can be determined whether there is a need to make an arbitrage rebate payment.
The proposed safe harbor sets forth six criteria to identify bond issues that are essentially "plain vanilla" issues and not transactions where any significant arbitrage is earned. An issuer of municipal tax-exempt bonds (or a borrower from a pool) would not be deemed to have earned arbitrage subject to the rebate requirement if all of the following criteria are met:
The Treasury recommendation generally follows the NACo-GFOA safe harbor proposal with significant changes.
One change would require some proof that 15 percent of the funds had been expanded in the first year as opposed to a determination prior to the sale that the issuer reasonably expects to meet this test.
Long-term bonds would be defined to include bonds with a weighted average maturity of at least 10 years as opposed to five years. This could be a problem for some counties and cities.
The Treasury proposal also would expand the $5 million small-issuer exception to $10 million. The estimated revenue loss over five years for the safe harbor and small-issue exception would be $59 million. This is far less than what counties, states and cities currently pay annually in compliance costs.
NACo and the other state and local groups will work closely with the House Ways and Means Committee and the Senate Finance Committee in further refining the safe harbor proposal.
All of the tax simplification recommendations would be made part of a
tax title to be included in a budget reconciliation bill later this summer.