Tax Policy
Tax-Exempt Status of Certain Bonds Merits Reconsideration, and Apparent Noncompliance with Issuance Cost Limitations Should Be Addressed Gao ID: GAO-08-364 February 15, 2008The outstanding amount of state and local government tax-exempt bonds has increased over the years. Congress is interested in whether the bonds are used for appropriate purposes since the federal government forgoes billions in tax revenues annually by excluding the bonds' interest from investors' federal gross income. Questions also exist over the bonds' borrowing costs as they can divert funds from the funded projects. This report (1) describes recent trends in tax exempt bonds, (2) provides information on the types of facilities financed with tax-exempt bonds, and (3) discusses borrowing costs considering the methods of selling bonds and compares issuance costs paid from bond proceeds for governmental and qualified private activity bonds. In addition to interviewing relevant officials, we analyzed IRS's Statistics of Income (SOI) data and data from Thomson Financial to address these objectives.
In recent years, the volume of tax-exempt bonds issued annually for both governmental and private activity bonds has reached historically high levels. Generally, the volume of new money bond issues has been greater than bonds issued for refunding purposes. The volume of tax-exempt bonds issued, particularly bonds issued for refunding, tends to be highest when interest rates decline. Because the interest earned by investors who purchase tax bonds is generally excluded from federal income taxes, the federal revenue losses amount to billions of dollars annually. Tax-exempt governmental and private activity bonds are used to finance a wide range of projects and activities, with bonds issued for "educational purposes" generally being the largest category of governmental bonds annually. Nonprofit organizations are the largest issuers of qualified private activity bonds. Previous legislation prohibited using qualified private activity bonds for certain facilities, including professional sports stadiums, hotels, and private golf courses. However, many of these types of facilities are still being financed with tax-exempt governmental bonds. Congress has held hearings on this issue primarily focusing on sports stadiums. Although the evidence is not definitive, studies have generally shown that interest costs are lower for bonds sold when competition between underwriters exists compared to when bond sales are negotiated with underwriters after controlling for other factors. About half of all issuers of qualified private activity bonds reported paying issuance costs from bond proceeds from 2002 to 2005. IRS's guidance does not indicate what to report when no issuance costs are paid from bond proceeds. Of those reporting issuance costs, some private activity bond issuers reported paying issuance costs from bond proceeds that exceed statutory limits.
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Director: Team: Phone:GAO-08-364, Tax Policy: Tax-Exempt Status of Certain Bonds Merits Reconsideration, and Apparent Noncompliance with Issuance Cost Limitations Should Be Addressed
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Report to the Committee on Finance, U.S. Senate:
United States Government Accountability Office:
GAO:
February 2008:
Tax Policy:
Tax-Exempt Status of Certain Bonds Merits Reconsideration, and Apparent
Noncompliance with Issuance Cost Limitations Should Be Addressed:
Tax Policy:
GAO-08-364:
GAO Highlights:
Highlights of GAO-08-364, a report to the Committee on Finance, U.S.
Senate.
Why GAO Did This Study:
The outstanding amount of state and local government tax-exempt bonds
has increased over the years. Congress is interested in whether the
bonds are used for appropriate purposes since the federal government
forgoes billions in tax revenues annually by excluding the bonds‘
interest from investors‘ federal gross income. Questions also exist
over the bonds‘ borrowing costs as they can divert funds from the
funded projects.
This report (1) describes recent trends in tax exempt bonds, (2)
provides information on the types of facilities financed with tax-
exempt bonds, and (3) discusses borrowing costs considering the methods
of selling bonds and compares issuance costs paid from bond proceeds
for governmental and qualified private activity bonds. In addition to
interviewing relevant officials, we analyzed IRS‘s Statistics of Income
(SOI) data and data from Thomson Financial to address these objectives.
What GAO Found:
In recent years, the volume of tax-exempt bonds issued annually for
both governmental and private activity bonds has reached historically
high levels. Generally, the volume of new money bond issues has been
greater than bonds issued for refunding purposes. The volume of tax-
exempt bonds issued, particularly bonds issued for refunding, tends to
be highest when interest rates decline. Because the interest earned by
investors who purchase tax bonds is generally excluded from federal
income taxes, the federal revenue losses amount to billions of dollars
annually.
Figure: total dollar amount of all long-term, tax-exempt bonds issued
annually, 1991 through 2005:
This figure is a bar graph showing total dollar amount of all long-
term, tax-exempt bonds issued annually, 1991 through 2005. The X axis
represents the year, and the Y axis represents the dollars in billions
(constant 2007 dollars).
[See PDF for image]
Source: GAO analysis of IRS‘s Statistics of Income Division data.
Note: Amounts include governmental and qualified private activity bonds
for new money and refunding bonds. Calendar year 2005 is the most
recent available IRS data.
[End of figure]
Tax-exempt governmental and private activity bonds are used to finance
a wide range of projects and activities, with bonds issued for
’educational purposes“ generally being the largest category of
governmental bonds annually. Nonprofit organizations are the largest
issuers of qualified private activity bonds. Previous legislation
prohibited using qualified private activity bonds for certain
facilities, including professional sports stadiums, hotels, and private
golf courses. However, many of these types of facilities are still
being financed with tax-exempt governmental bonds. Congress has held
hearings on this issue primarily focusing on sports stadiums.
Although the evidence is not definitive, studies have generally shown
that interest costs are lower for bonds sold when competition between
underwriters exists compared to when bond sales are negotiated with
underwriters after controlling for other factors. About half of all
issuers of qualified private activity bonds reported paying issuance
costs from bond proceeds from 2002 to 2005. IRS‘s guidance does not
indicate what to report when no issuance costs are paid from bond
proceeds. Of those reporting issuance costs, some private activity bond
issuers reported paying issuance costs from bond proceeds that exceed
statutory limits.
What GAO Recommends:
Congress should consider whether facilities, including hotels and golf
courses, that are privately used should be financed with tax-exempt
governmental bonds. GAO also recommends that IRS clarify how bond
issuers report issuance costs and develop methods to detect and address
apparent noncompliance with limits on using bond proceeds for issuance
costs.
In response, the Acting IRS Commissioner agreed with our
recommendations and outlined the actions IRS would take.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.GAO-08-364]. For more information, contact
Michael Brostek at (202) 512-9110 or brostekm@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
In Recent Years, the Dollar Amount of Long-term Tax-Exempt Bonds Issued
Annually Has Been at Historically High Levels, and the Tax Exemption Is
One of the Largest Federal Tax Expenditures:
Tax-Exempt Bonds Are Used to Finance a Wide Range of Facilities and
Activities:
Borrowing Costs Vary Depending on Bond Characteristics, and Some Bonds
Appear to Exceed the Statutory Limit on Issuance Costs Paid from Bond
Proceeds:
Conclusions:
Matter for Congressional Consideration:
Recommendations for Executive Action:
Agency Comments:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Sources of Information on the Facilities and Activities
Financed Using Tax-Exempt Bonds:
Appendix III: Summary of Thomson Financial 2007 Bond Buyer Yearbook
Data, Use of Proceeds, 2002-2006 Combined:
Appendix IV: Amount and Number of New Money, Long-term Governmental
Bonds Issued by IRS SOI Purpose Categories, 2001-2005 Combined:
Appendix V: List of Studies Reviewed on Interest Costs in Competitive
and Negotiated Sales:
Appendix VI: Comments from the Internal Revenue Service:
Appendix VII: Comments from the Department of the Treasury:
Appendix VIII: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: The Amounts of Long-term Tax-Exempt Bonds Issued for New Money
and Refunding Purposes, 1991 to 2005:
Table 2: Summary of Bond Buyer Yearbook Data on Uses of Municipal Bonds
Issued in Calendar Year 2006:
Table 3: Summary of Facilities and Activities Financed with Tax-Exempt
Bonds Issued in 2006 Based on a Limited Sample of 40 Official
Statements:
Table 4: Summary of Facilities and Activities Financed with New Money,
Long-term Tax-Exempt Private Activity Bonds Issued in 2005:
Table 5: New Types of Private Activity Bonds Created since 2001:
Table 6: New Hotels Financed with Tax-Exempt Governmental Bonds Issued
from 2002 through 2006:
Table 7: Municipal Golf Courses Opened in 2005 and Financed with Tax-
Exempt Governmental Bonds:
Table 8: Median Issuance Costs Paid from Bond Proceeds as a Percentage
of Bond Proceeds for Long-term Qualified Private Activity Bonds Issued
from 2002 to 2005:
Table 9: Median Issuance Costs as a Percentage of Bond Proceeds for
Long-term Governmental Bonds Issued from 2002 to 2005:
Figures:
Figure 1: Total Dollar Amounts of All Long-term Tax-Exempt Bonds Issued
Annually from 1991 through 2005:
Figure 2: Comparison of the Dollar Amounts of Long-term Governmental
and Qualified Private Activity Bonds Issued from 1991 through 2005:
Figure 3: Percentage Change in New Money and Refunding Issues versus
Changes in Interest Rates, 1992 through 2005:
Figure 4: Estimated Revenue Loss from Excluding Interest Earned on Tax-
Exempt Bonds from Federal Income Tax, 2000 through 2012:
Figure 5: Dollar Amount and Number of New Money, Long-term Governmental
Bonds Issued in 2005 by IRS SOI Purpose Categories:
Abbreviations:
AMT: alternative minimum tax:
I.R.C.: Internal Revenue Code:
IRS: Internal Revenue Service:
JCT: Joint Committee on Taxation:
MSRB: Municipal Securities Rulemaking Board:
SOI: Statistics of Income Division Treasury:
Department of the Treasury:
United States Government Accountability Office:
Washington, DC 20548:
February 15, 2008:
The Honorable Max Baucus:
Chairman:
The Honorable Charles E. Grassley:
Ranking Member:
Committee on Finance:
United States Senate:
The outstanding volume of state and local government tax-exempt bond
debt grew significantly from about $1.4 trillion in 2000 to over $2.1
trillion in 2006 in constant 2007 dollars. Because the tax exemption
allows taxpayers to generally exclude the bond interest from their
federal gross income, the federal government forgoes tax revenue.
According to our analysis of the Department of the Treasury's
(Treasury) estimates, forgone federal tax revenues were about $32.0
billion in 2000 and were projected to be about $37.0 billion in
2007.[Footnote 1] Congressional interest in the use of tax-exempt bonds
has heightened because of the large dollar amounts of bonds outstanding
coupled with the large amounts of forgone federal tax revenues.
State and local governments have broad discretion in using tax-exempt
bonds to finance public infrastructure and other projects. Although
state and local governments (and certain nonprofit entities) can use
tax-exempt bond financing to subsidize activities of private entities,
Congress previously placed limitations on the use of such financing for
specific private activities and, in general, has limited the annual
volume on such bonds.[Footnote 2] For example, Congress allows the use
of tax-exempt bonds for privately owned facilities such as airports,
docks, and wharves subject to annual state-by-state volume caps. In
addition, there are special rules for providing tax-exempt bond
financing for private uses within certain geographic areas (e.g.,
enterprise and empowerment zones, the New York Liberty Zone, and the
Gulf Opportunity Zone) to provide incentives for economic development.
Because issuing bonds can be a complex process requiring specialized
services in planning and selling the bonds, congressional interest has
also focused on the borrowing costs, including interest costs and
issuance costs, that bond issuers pay when bonds are issued. Concerns
have focused on the methods of selling the bonds because this might
affect the interest costs paid by municipal governments and ultimately
the amount of federal forgone revenues. Further, issuance costs can
divert bond proceeds from the facilities and activities for which the
bonds were intended to be used.
To support Congress's efforts to review the types of facilities and
activities that are financed with tax-exempt bonds and understand the
factors affecting the costs of issuing the bonds, you requested this
study. Our objectives were to:
* describe recent trends in the dollar volume of tax-exempt bonds;
* provide information on the types of facilities and activities that
are financed with tax-exempt bonds, in particular, information on
hotels and municipal golf courses that were recently financed with tax-
exempt bonds; and:
* provide information on borrowing costs that bond issuers pay by
summarizing relevant research on whether bond interest costs vary by
the method of sale, considering characteristics of the bond and bond
issuer and providing information on how bond issuance costs vary
between governmental and private activity bonds, including the extent
to which private activity bond issuers exceed the statutory limit for
issuance costs as a percentage of bond proceeds.
To address our objectives, we obtained information from several sources
that are recognized as being reliable sources for data on tax-exempt
bonds. To describe recent trends in the dollar amounts and numbers of
tax-exempt bonds, we used data from the Internal Revenue Service's
(IRS) Statistics of Income Division (SOI), which collects data from the
information returns issuers of tax-exempt bonds are required to file
with IRS. We also used data contained in the Bond Buyer Yearbook, a
publication that summarizes information on bond issuances that is
widely used as a reference by bond industry experts. To provide
information on the facilities and activities financed using tax-exempt
bonds, we relied on data from SOI, the Bond Buyer Yearbook, and a
limited random sample of official statements for tax-exempt bonds.
Official statements are used to market the bonds and contain
descriptive information on the facilities and activities financed using
the bonds. Because we could not find a comprehensive source of
information on hotels and municipal golf courses financed with tax-
exempt bonds, we provide some limited data from the best available
sources we could identify. To provide information on borrowing costs
associated with tax-exempt bonds, we summarized relevant recent
research on whether interest costs vary considering the method of sale
and analyzed SOI data on issuance cost as reported to IRS by bond
issuers. For information pertaining to our work in general, we
interviewed officials in IRS's Tax-Exempt Bond Office in its Government
Entities and Tax-Exempt Division and Treasury's Office of Tax Policy
and other experts in taxation and government finance in the Government
Finance Officers' Association, the Securities Industry and Financial
Markets Association, and the Congressional Research Service.
We determined that the data we used in this report were sufficiently
reliable for our purposes. Appendix I provides a detailed description
of our methodology, sources, and limitations. We conducted our work
from December 2006 through January 2008 in accordance with generally
accepted government auditing standards.
Results in Brief:
Since 2002, the dollar amount of long-term tax-exempt bonds issued
annually has reached historically high levels. Governmental bonds,
which are generally issued for traditional public purposes, account for
the majority of the bonds issued each year. However, the dollar volume
of qualified private activity bonds, which provide tax-exempt financing
for facilities and activities that are private in nature and meet
certain legal requirements, has also been noticeably higher in recent
years. More than half of the bonds issued are new money issues, that
is, bonds for new facilities and activities. Because the interest
income that investors earn from tax-exempt bonds is generally not
included in their federal gross income, the cost to the federal
government is significant and growing. Based on estimates by Treasury
and the Joint Committee on Taxation (JCT), the federal government
forgoes tens of billions of dollars of revenue annually.
The majority of governmental bonds are used for purposes related to
education, transportation, and public facilities and activities,
whereas qualified private activity bonds are mostly used by
501(c)(3)[Footnote 3] nonprofit organizations and entities, such as
governmental authorities specifically established to support private
activities, such as airports, docks, wharves, and other facilities
often intended to generate economic development. In the 1980s, Congress
passed laws that limited the dollar amount of private activity bonds
that could be issued in a given year as well as specifying certain
facilities as not being eligible for tax-exempt private activity bond
financing, including sports stadiums, hotels, and private golf courses.
However, tax-exempt governmental bonds can still be used to finance
some of these types of facilities and projects for which tax-exempt
private activity bonds can no longer be used. Based on limited
information, we found 18 newly constructed hotels that were financed in
whole or in part with governmental bonds issued from 2002 through 2006.
Also, based on limited information, we found that six municipal golf
courses that opened in 2005 were financed by governmental bonds. Recent
congressional hearings have raised questions about using governmental
bonds for purposes that are private in nature, such as professional
sports stadiums, but similar attention has not been focused on other
types of facilities that are essentially private in nature.
Although the results varied, recent studies generally showed that the
competitive method of selling municipal bonds has lower interest costs,
after controlling for other factors, than using the negotiated method
of sale. However, several recently issued studies also show that there
is not a statistically significant difference in interest costs for
bonds sold on a competitive versus negotiated basis. Bond issuance
costs vary by size and type of bond for both governmental and private
activity bonds. Smaller bonds tend to report higher issuance costs as a
percentage of bond proceeds than larger bonds. Some qualified private
activity bonds issued from 2002 through 2005 reported issuance costs
paid from bond proceeds that exceed statutory limits, an apparent
violation of applicable federal laws. For example, from 2002 to 2005,
between 17 and 39 qualified private activity bonds annually--about 1 to
2 percent of qualified private activity bonds that reported issuance
costs paid from bond proceeds--reported issuance costs that exceeded
applicable statutory limits. IRS officials said that these apparent
violations merited investigation, but given the large lost revenue
implications of certain other forms of noncompliance, IRS would have to
address low-cost options for addressing violations of issuance cost
restrictions. Over half of the issuers of qualified private activity
bonds issued from 2002 through 2005 reported issuance costs paid from
bond proceeds, but for nearly half of issued bonds the issuers left the
line on issuance costs blank when reporting to IRS. IRS cannot be sure
it is able to detect nonreporting and address apparent violations with
the statutory limit on using bond proceeds for issuance costs, in part
because its instructions to issuers do not clearly indicate what to
report to IRS when no bond proceeds are used for issuance costs.
As Congress considers whether tax-exempt governmental bonds should be
used for professional sports stadiums that are generally privately
used, it should also consider whether other facilities, including
hotels and golf courses, that are privately used should continue to be
financed with tax-exempt governmental bonds. Additionally, to help IRS
better monitor whether issuers of qualified private activity bonds are
complying with the statutory limit on using bond proceeds for issuance
costs, we recommend that the Commissioner of Internal Revenue (1)
clarify IRS's forms and instructions for reporting issuance costs paid
from bond proceeds so that bond issuers are required to clearly
designate on the form instances where bond proceeds were not used to
pay issuance costs and (2) develop cost-effective methods to address
apparent noncompliance with the statutory limits in a manner that would
not preclude IRS from examining the bonds for more substantive
compliance issues in the future.
The Acting Commissioner of Internal Revenue provided comments on a
draft of this report in a February 7, 2008, letter. She said that IRS
agrees with our recommendations and indicated specific actions it plans
to take to address them. The Treasury Assistant Secretary for Tax
Policy also provided comments on a draft of this report in a February
8, 2008, letter. Treasury's comments focused on use of tax-exempt
governmental bonds to finance stadiums and other projects with
significant private business use. Treasury said that this is arguably a
structural weakness in the targeting of the federal tax expenditure for
tax-exempt bonds under the existing legal framework and noted options
to address this structural weakness. Written comments from IRS are
reprinted in appendix VI and written comments from Treasury are
reprinted in appendix VII.
Background:
Tax-exempt bonds are valid debt obligations of state and local
governments. Under Section 103 of the Internal Revenue Code (I.R.C.),
the interest earned on most bonds issued by state and local governments
is tax-exempt. This means that the interest paid to bondholders is
generally not included in their gross income for federal income tax
purposes.[Footnote 4] The tax exemption lowers the bond issuer's
borrowing costs and may provide equivalent or higher after-tax yields
to investors than alternative investments that are not tax-exempt. Tax-
exempt bond financing can apply to different types of debt financing
arrangements, including notes, loans, commercial paper, certificates of
participation, and tax-increment financing.[Footnote 5] The tax-exempt
status remains throughout the life of the bonds provided that all
applicable laws are satisfied. IRS's Tax-Exempt Bond Office in its Tax
Exempt and Government Entities division is responsible for
administering tax laws pertaining to tax-exempt bonds.
Tax-exempt bonds can be characterized as new money and refunding
issues. New money issues refer to bonds used to finance a new project.
A refunding issue refers to any bond issue used to pay debt service on
and retire an outstanding issue. Typically, refunding is done for
reasons such as to reduce the interest rate and ease restrictions on
the original bond contract. Refunding issues are either current or
advanced based on the timing between the issuance of the new bonds and
the maturity date of the outstanding bonds. Current refunding occurs
when new bonds are issued within 90 days of the final payment on the
prior issue and advance refunding occurs if the new bonds are issued
more than 90 days before final payment on the prior issue.
For federal tax purposes municipal bonds are classified as either
governmental bonds or private activity bonds. In general, governmental
bonds are tax-exempt and are used to build public capital facilities
and serve the general public interest. The I.R.C. does not specifically
define governmental bonds; rather, all municipal bonds that do not meet
the criteria to be classified as private activity bonds are
governmental bonds. Municipal bonds are classified as private activity
bonds, which provide financing to private businesses, if they pass both
the private payment and the private business use test. These tests
specify that if more than 10 percent of the bond proceeds are used for
private business purposes and more than 10 percent of the bond proceeds
are secured by payments from property used for private business use,
then the bond is a private activity bond. A bond that is classified as
a private activity bond can be taxable or tax-exempt. Congress has
specified certain private activities (see tables 4 and 5) that can be
financed with tax-exempt bonds. Private activity bonds that receive tax-
exempt status are called qualified private activity bonds. Private
activities that are not "qualified" are taxable.
Generally, qualified private activity bonds are subject to a number of
restrictions that do not apply to governmental bonds, including a 2
percent limit on using proceeds of the bond sale to pay issuance
costs,[Footnote 6] annual state-by-state limitations on the volume of
bonds that can be issued, and the disallowance for advanced refunding.
In addition, the interest income from qualified private activity bonds
is an addition to income for purposes of calculating the alternative
minimum tax (AMT) whereas the interest on governmental bonds is
not.[Footnote 7] However, some exceptions to these restrictions exist
for qualified 501(c)(3) private activity bonds[Footnote 8] issued by or
on behalf of nonprofit entities. Qualified 501(c)(3) bonds do not count
toward annual state-by-state volume limits; the interest income on
these bonds issued after August 7, 1986, is not subject to AMT rules;
and unlike other qualified private activity bonds, qualified 501(c)(3)
bonds can be advance refunded.
Tax-exempt bonds can be structured as general obligation or revenue
bonds. General obligation bonds, also known as full faith and credit
obligations, are secured by revenues obtained from the issuer's general
taxing powers, including sales taxes, property taxes, and income taxes.
Most general obligation bonds are used to build public infrastructure,
such as school buildings, jails, police stations, and city halls, and
are classified as governmental bonds for tax purposes. In contrast,
revenue bonds are issued to finance specific projects or enterprises
and investors get paid from the revenues generated by the financed
projects. Revenue bonds can be either governmental bonds or private
activity bonds for tax purposes.
In addition to issuing tax-exempt bonds directly, state and local
governments may establish other entities to issue bonds "on behalf of"
such governmental units, or any political subdivision thereof.[Footnote
9] For example, a specifically constituted nonprofit corporation acting
on behalf of governmental units might own, operate, and issue debt to
finance a local airport. In addition to issuing bonds for government
operations and services, qualified governmental units are permitted to
issue qualified private activity bonds to provide tax-exempt financing
for certain private activities. In these cases, the qualified
governmental unit generally acts as a conduit, meaning that the
qualified governmental unit issues the bonds, but the nongovernmental
entity receiving the benefit of tax-exempt financing is required to
provide the funds to repay the bonds.
Municipal governments incur costs to issue their bonds. Bond issuance
costs include the underwriting spread, which is the difference between
the price paid to the issuer by the underwriter and the price at which
the bonds are reoffered to investors, and fees for bond counsel,
financial advisors, public hearings, printing, and other costs. In
addition, at the time bonds are issued, issuers may choose to purchase
bond insurance or secure a line of credit to further ensure that
principal and interest payments will be made on time. This additional
security can improve the bond's credit rating and result in lower
interest costs over time for bond issuers. Bond insurance or other
types of credit designed to ensure the timely repayment of bonds may
not count as issuance costs for the purposes of calculating the 2
percent limit with which qualified private activity bonds generally
must comply.
Bond issuers have two principal avenues for marketing their bonds in
the primary market[Footnote 10]--competitive bids and negotiated
sales.[Footnote 11] In competitive bids, underwriters who sell the
bonds compete against each other to market the bonds for the issuer,
while in negotiated sales, the issuer selects the underwriter and
negotiates the terms of the bond sale. The majority of tax-exempt bonds
are issued through negotiated sales. Guidance issued in 1996 and
revised in 2007 by the Government Finance Officers' Association on the
preferred method of sale emphasized that both methods offer advantages
in different circumstances. Generally, competitive sales are favored in
cases when the bond has a relatively high credit rating; the bond is
secured by strong, long-standing revenue streams; and the structure of
the bond does not include innovative financing methods that require
explanation to the bond market. Negotiated sales may be preferred in
cases where a bond with relatively complex features is to be issued
during a time period with volatile interest rates, giving the
underwriter and the issuer more flexibility in terms of the timing of
the bond issue and the underwriter more time to search for investors
better suited to more complex bonds. The revised guidance on the
preferred method of sale puts more emphasis on the advantages for
issuers to obtain financial advice that is independent from the
underwriter.
In offering bonds for sale, various documents may be prepared,
including a preliminary (announcing the prospective bond sale) and
final (after the bonds have been issued) official statement. Official
statements contain information describing the bond issue, including the
dollar amount, maturity dates, financing arrangements, and information
on the types of facilities and activities being financed. A copy of the
final official statement is required to be sent to the Municipal
Securities Rulemaking Board (MSRB), a congressionally chartered
organization that regulates securities firms and banks involved in
underwriting, trading, and selling municipal securities.
In Recent Years, the Dollar Amount of Long-term Tax-Exempt Bonds Issued
Annually Has Been at Historically High Levels, and the Tax Exemption Is
One of the Largest Federal Tax Expenditures:
Based on IRS data, the dollar amounts of long-term tax-exempt bonds
issued have been at their highest levels in recent years. Since 2002,
the dollar amount of long-term, tax-exempt bonds issued has exceeded
$395 billion annually.[Footnote 12] In only 2 earlier years from the
period 1991 through 2001, did the annual amount of bonds issued exceed
$350 billion. Furthermore, during this same period, municipal
governments never issued more bonds than in recent years. Figure 1
shows the annual dollar amount of long-term, tax-exempt governmental
and private activity bonds, including new money and refunding bonds,
issued from 1991 through 2005.
Figure 1: Total Dollar Amounts of All Long-term Tax-Exempt Bonds Issued
Annually from 1991 through 2005:
This figure is a bar graph showing total dollar amount of all long-
term, tax-exempt bonds issued annually, 1991 through 2005. The X axis
represents the year, and the Y axis represents the dollars in billions
(constant 2007 dollars).
[See PDF for image]
Source: GAO analysis of IRS‘s Statistics of Income Division data.
Note: Amounts presented each year include governmental and qualified
private activity bonds for new money and refunding bonds. Calendar year
2005 is the most recent available IRS data.
[End of figure]
The recent increases in the dollar amounts of governmental bonds issued
have been a leading factor contributing to the high volume of tax-
exempt bonds issued since 2002. Figure 2 compares the annual dollar
amounts of governmental and qualified private activity bonds issued
from 1991 through 2005. In recent years, that is, 2002 through 2005, at
least $295 billion of governmental bonds have been issued annually, or
on average about $314.8 billion per year. In comparison, in the earlier
years of 1991 through 2001, the average amount of governmental bonds
issued annually was about $194.3 billion, or about 62 percent less than
the average annual amounts from 2002 through 2005 after adjusting for
inflation.
Similar to governmental bonds, the amounts of private activity bonds
issued annually has also been at peak levels since 2002. From 2002
through 2005, over $100 billion dollars in qualified private activity
bonds were issued each year. About $116 billion of qualified private
activity bonds were issued in 2005, more than in any other year since
1998. The average dollar amount of qualified private activity bonds
issued annually from 2002 through 2005 was about $106.7 billion. In
comparison, in the earlier years of 1991 through 2001, the average
amount of qualified private activity bonds issued annually was about
$86.1 billion, or about 24 percent less than the average annual amounts
from 2002 through 2005 after adjusting for inflation. Thus, though not
as large as the comparable increase for governmental bonds, there has
been a noticeable increase in the amount of qualified private activity
bonds issued recently.
Figure 2: Comparison of the Dollar Amounts of Long-term Governmental
and Qualified Private Activity Bonds Issued from 1991 through 2005:
This figure is a combination bar graph showing comparison of the dollar
amounts of long-term governmental and qualified private activity bonds
issued from 1991 through 2005. The X axis represents the year, and the
Y axis represents the dollars in millions. One bar in the graph
represents governmental bonds, and the other represents private
activity bonds.
[See PDF for image]
Source: GAO analysis of IRS's Statistics of Income Division data.
[End of figure]
While both governmental and qualified private activity bonds reached
historically high levels recently, the amount of governmental bonds
issued annually has fluctuated to a greater extent. For example, from
1992 to 2005, the dollar amounts of governmental bonds issued annually
either increased or decreased by an average of about 25 percent per
year. In contrast, qualified private activity bonds fluctuated to a
lesser extent, by an average of about 13 percent per year. The wider
fluctuation in governmental bonds could be in part because governmental
bonds are not subject to as many restrictions, including annual state-
by-state volume caps, as qualified private activity bonds. Even if the
volume cap for private activity bonds is not reached for all states,
the volume cap can place constraints on the volume of private activity
bonds issued because some individual states may reach their limits and
this would restrict them from issuing any additional qualified private
activity bonds that year.[Footnote 13]
Another way to analyze the dollar amount of tax-exempt bonds is to
compare new money bonds to refunding bonds. Although the amount of
refundings substantially increased around 2002, new money bond issues
were generally higher than refunding issues each year since 1991. Since
1991, the dollar amount of refundings has been greater than new money
issues in only 3 years--1992, 1993, and 2005. From 2001 through 2005,
the amount of new money tax-exempt bond issues has exceeded $200
billion annually (in constant dollars). This is greater than any year
from 1991 through 2000. Table 1 shows the annual volume and percentage
of long-term, tax-exempt bonds issued for new money and refunding
purposes from 1991 through 2005.
Table 1: The Amounts of Long-term Tax-Exempt Bonds Issued for New Money
and Refunding Purposes, 1991 to 2005:
Dollars in millions (constant 2007 dollars).
Year: 1991;
New money: $146,746;
Percentage of total: 62.5;
Refunding: $ 88,188;
Percentage of total: 37.5.
Year: 1992;
New money: 144,697;
Percentage of total: 45.3;
Refunding: 174,969;
Percentage of total: 54.7.
Year: 1993;
New money: 128,582;
Percentage of total: 33.2;
Refunding: 258,222;
Percentage of total: 66.8.
Year: 1994;
New money: 139,764;
Percentage of total: 59.9;
Refunding: 93,487;
Percentage of total: 40.1.
Year: 1995;
New money: 125,931;
Percentage of total: 63.5;
Refunding: 72,360;
Percentage of total: 36.5.
Year: 1996;
New money: 140,312;
Percentage of total: 59.1;
Refunding: 97,179;
Percentage of total: 40.9.
Year: 1997;
New money: 152,271;
Percentage of total: 57.6;
Refunding: 112,233;
Percentage of total: 42.4.
Year: 1998;
New money: 192,762;
Percentage of total: 54.4;
Refunding: 161,694;
Percentage of total: 45.6.
Year: 1999;
New money: 184,067;
Percentage of total: 66.0;
Refunding: 94,831;
Percentage of total: 34.0.
Year: 2000;
New money: 173,223;
Percentage of total: 72.0;
Refunding: 67,385;
Percentage of total: 28.0.
Year: 2001;
New money: 203,402;
Percentage of total: 60.7;
Refunding: 131,955;
Percentage of total: 39.3.
Year: 2002;
New money: 227,899;
Percentage of total: 54.1;
Refunding: 193,494;
Percentage of total: 45.9.
Year: 2003;
New money: 225,440;
Percentage of total: 53.4;
Refunding: 196,723;
Percentage of total: 46.6.
Year: 2004;
New money: 224,850;
Percentage of total: 56.7;
Refunding: 171,688;
Percentage of total: 43.3.
Year: 2005;
New money: 218,491;
Percentage of total: 49.0;
Refunding: 227,287;
Percentage of total: 51.0.
Source: GAO analysis of IRS's Statistics of Income Division data.
Note: Totals include both governmental and qualified private activity
bonds.
[End of table]
Tax-exempt bond issuers tend to issue more debt when interest rates
decline. Since 1991, years when interest rates were at their lowest
levels generally have corresponded with the years in which the amounts
of tax-exempt bonds issued, including bonds for refunding, were the
highest. For example, since 2002, average interest rates on tax-exempt
bonds[Footnote 14] have fallen to their lowest levels since the early
1970s. During this same time period, the dollar amount of tax-exempt
bonds issued has been at the highest level since 1993.
Figure 3 shows how changes in interest rates have corresponded with the
amounts of new money and refunding bonds. As the figure illustrates,
generally, increases in the dollar amounts of bonds that were refunded
have accompanied declines in interest rates. This indicates that
municipal governments tend to take advantage of interest rate declines
to restructure existing bond debt to obtain more attractive financing
terms, such as obtaining a lower interest rate to reduce borrowing
costs. On the other hand, changes in the dollar amounts of new bond
issues do not appear to correspond as closely to interest rate changes
as the amounts of refundings. One explanation for this could be that
municipal governments tend to issue new bonds based on current needs to
finance operations and activities, and decisions regarding new
financing are likely to be less sensitive to interest rates.
Figure 3: Percentage Change in New Money and Refunding Issues versus
Changes in Interest Rates, 1992 through 2005:
This figure is a combination bar and line graph showing percentage
change in new money and refunding issues versus changes in interest
rates, 1992 through 2005. The X axis represents the year, the left Y
axis represents percent changes in dollar amount issued, and the right
Y axis represents percent changes in interest rates. One bar represents
percent change in new money, and the other bar represents percent
change in refunding. The line represents percent change in interest
rates.
[See PDF for image]
Source: GAO analysis of IRS‘s Statistics of Income Division data and
Thomson Financial data in the Bond Buyer Yearbook.
[End of figure]
The Estimated Revenue Loss from Outstanding Tax-Exempt Bonds Is One of
the Largest Federal Tax Expenditures:
Because the interest earned by investors who purchase tax-exempt bonds
is generally excluded from federal income taxes, the federal government
incurs a revenue loss each year. Revenue loss estimates are based on
the total dollar value of outstanding tax-exempt bonds and not on the
dollar amounts of tax-exempt bonds issued in a given year. Both
Treasury and JCT provide estimates of the revenue loss associated with
tax-exempt bonds. Though calculated differently, both estimates show
that the revenue loss is in the billions of dollars annually.
According to our analysis of Treasury's estimates, the revenue loss
from excluding the interest earned on tax-exempt bonds from federal
income tax is the ninth largest tax expenditure in the I.R.C. in 2007.
Figure 4 shows our analysis of Treasury's revenue loss estimates from
2000 to 2012. The estimates indicate that the federal government could
lose about $37 billion in 2007--$25.4 billion from interest on
governmental bonds and $11.6 billion from interest on qualified private
activity bonds.[Footnote 15] As figure 4 shows, the estimated revenue
loss from governmental bonds has fluctuated from a high of $30.1
billion in 2003 to a low of $23.6 billion in 2006. According to our
analysis of Treasury's estimates, the revenue loss is likely to be
about $27.9 billion from governmental bonds and about $12.6 billion
from qualified private activity bonds by 2012.
Figure 4: Estimated Revenue Loss from Excluding Interest Earned on Tax-
Exempt Bonds from Federal Income Tax, 2000 through 2012:
This figure is a line graph with shaded portions of the graph. The
graph is showing estimated revenue loss from excluding interest earned
on tax exempt bonds from federal income tax, 2000 through 2012. The X
axis represents the year, and the Y axis represents the dollars in
billions. The light section represents qualified private activity
bonds, and the dark section represents government bonds.
[See PDF for image]
Source: GAO Analysis of Treasury Department Estimates Printed in the
President's 2002, 2004, 2006,and 2008 Budgets, Analytical Perspective.
Note: Summing the individual tax preference estimates is useful for
gauging the general magnitude of the federal revenue involved, but it
does not take into account possible interactions between individual
provisions. All data points presented are estimates, but data points
for future years are also projections.
[End of figure]
JCT estimates also suggest a similar pattern of higher estimated
revenue losses attributable to excluding the interest earned on tax-
exempt bonds from federal gross income in future years. For example, in
2007, JCT reported that the federal government would forgo about $27.8
billion due to tax-exempt governmental bonds and projected that the
revenue losses would grow to about $31.9 billion in 2011. For qualified
private activity bonds, our analysis of JCT estimates shows the revenue
loss increasing from $8.6 billion in 2007 to about $10.1 billion in
2011, an 18 percent increase.[Footnote 16]
Tax-Exempt Bonds Are Used to Finance a Wide Range of Facilities and
Activities:
Tax-exempt governmental and private activity bonds are used to finance
a wide range of facilities and activities, primarily in support of the
entity responsible for paying the bond debt service. Information
describing the types of facilities and activities that are financed
with tax-exempt bonds is available from several sources. In addition,
tax-exempt governmental bonds can be used to finance some facilities
and activities for which most tax-exempt private activity bonds cannot,
including some facilities that Congress specifically prohibited from
being financed with qualified private activity bonds.
To illustrate the wide range of purposes for which tax-exempt bonds are
used, we reviewed the most recent information available on bonds in
Thomson Financial's Bond Buyer Yearbook and IRS's SOI data. We also
reviewed a limited sample of official statements to further illustrate
the uses of tax-exempt bonds. Because most of the information is
summarized by broad descriptive categories, it does not fully reveal
the wide range of facilities and activities for which tax-exempt bonds
can be used. Appendix II describes the primary sources for information
on the facilities and activities financed with tax-exempt bonds.
Uses of Municipal Bonds Based on Bond Buyer Yearbook Data:
The Bond Buyer Yearbook contains historical data and is a resource and
reference tool for portfolio managers, underwriters, financial
advisors, and other professionals seeking information on municipal
bonds. As previously stated, the yearbook does not separate information
on the uses of bonds based on whether the bonds are governmental,
qualified private activity, or taxable bonds. Nonetheless, the Bond
Buyer Yearbook still provides a general sense of the types of projects
financed with tax-exempt bonds. Table 2 summarizes Thomson Financial
2006 data in the 2007 Bond Buyer Yearbook by 10 major categories and 48
subcategories. The table also shows the proportion of bonds issued for
each category and subcategory.
Table 2: Summary of Bond Buyer Yearbook Data on Uses of Municipal Bonds
Issued in Calendar Year 2006:
Dollars in thousands (nominal 2006 dollars).
Category: Development;
Total amount: $4,891,000;
Percentage of total amount for all categories: 1.3;
Total issues: 387;
Percentage of total issues for all categories: 3.0;
Average size: $12,638.
Category: Industrial;
Total amount: 2,279,900;
Percentage of total amount for all categories: 0.6;
Total issues: 224;
Percentage of total issues for all categories: 1.8;
Average size: 10,178.
Category: Economic;
Total amount: 2,367,300;
Percentage of total amount for all categories: 0.6;
Total issues: 152;
Percentage of total issues for all categories: 1.2;
Average size: 15,574.
Category: Office buildings;
Total amount: 243,800;
Percentage of total amount for all categories: 0.1;
Total issues: 11;
Percentage of total issues for all categories: 0.1;
Average size: 22,164.
Category: Education;
Total amount: 106,545,800;
Percentage of total amount for all categories: 27.4;
Total issues: 4,197;
Percentage of total issues for all categories: 33.0;
Average size: 25,386.
Category: Primary;
Total amount: 60,492,500;
Percentage of total amount for all categories: 15.6;
Total issues: 3,380;
Percentage of total issues for all categories: 26.5;
Average size: 17,897.
Category: Higher;
Total amount: 29,447,800;
Percentage of total amount for all categories: 7.6;
Total issues: 650;
Percentage of total issues for all categories: 5.1;
Average size: 45,304.
Category: Student loans;
Total amount: 16,051,200;
Percentage of total amount for all categories: 4.1;
Total issues: 82;
Percentage of total issues for all categories: 0.6;
Average size: 195,746.
Category: Other;
Total amount: 554,300;
Percentage of total amount for all categories: 0.1;
Total issues: 85;
Percentage of total issues for all categories: 0.7;
Average size: 6,521.
Category: Electric power;
Total amount: 12,897,200;
Percentage of total amount for all categories: 3.3;
Total issues: 177;
Percentage of total issues for all categories: 1.4;
Average size: 72,866.
Category: Environmental facilities;
Total amount: 7,869,800;
Percentage of total amount for all categories: 2.0;
Total issues: 154;
Percentage of total issues for all categories: 1.2;
Average size: 51,103.
Category: Pollution control;
Total amount: 6,206,800;
Percentage of total amount for all categories: 1.6;
Total issues: 95;
Percentage of total issues for all categories: 0.7;
Average size: 65,335.
Category: Solid waste;
Total amount: 1,663,000;
Percentage of total amount for all categories: 0.4;
Total issues: 59;
Percentage of total issues for all categories: 0.5;
Average size: 28,186.
Category: Recycling;
Total amount: 0;
Percentage of total amount for all categories: 0.0;
Total issues: 0;
Percentage of total issues for all categories: 0.0;
Average size: 0.
Category: Health care;
Total amount: 40,102,200;
Percentage of total amount for all categories: 10.3;
Total issues: 827;
Percentage of total issues for all categories: 6.5;
Average size: 48,491.
Category: General acute;
Total amount: 30,871,100;
Percentage of total amount for all categories: 7.9;
Total issues: 518;
Percentage of total issues for all categories: 4.1;
Average size: 59,597.
Category: Single specialty;
Total amount: 475,400;
Percentage of total amount for all categories: 0.1;
Total issues: 20;
Percentage of total issues for all categories: 0.2;
Average size: 23,770.
Category: Children's;
Total amount: 1,398,600;
Percentage of total amount for all categories: 0.4;
Total issues: 14;
Percentage of total issues for all categories: 0.1;
Average size: 99,900.
Category: Equipment loans;
Total amount: 58,400;
Percentage of total amount for all categories: 0.0;
Total issues: 3;
Percentage of total issues for all categories: 0.0;
Average size: 19,467.
Category: General medical;
Total amount: 1,384,400;
Percentage of total amount for all categories: 0.4;
Total issues: 19;
Percentage of total issues for all categories: 0.1;
Average size: 72,863.
Category: Nursing homes;
Total amount: 474,900;
Percentage of total amount for all categories: 0.1;
Total issues: 34;
Percentage of total issues for all categories: 0.3;
Average size: 13,968.
Category: Assisted living;
Total amount: 914,700;
Percentage of total amount for all categories: 0.2;
Total issues: 66;
Percentage of total issues for all categories: 0.5;
Average size: 13,859.
Category: Continuing care;
Total amount: 4,524,700;
Percentage of total amount for all categories: 1.2;
Total issues: 153;
Percentage of total issues for all categories: 1.2;
Average size: 29,573.
Category: Housing;
Total amount: 30,532,700;
Percentage of total amount for all categories: 7.9;
Total issues: 955;
Percentage of total issues for all categories: 7.5;
Average size: 31,971.
Category: Single family;
Total amount: 24,107,400;
Percentage of total amount for all categories: 6.2;
Total issues: 606;
Percentage of total issues for all categories: 4.8;
Average size: 39,781.
Category: Multifamily;
Total amount: 6,425,300;
Percentage of total amount for all categories: 1.7;
Total issues: 349;
Percentage of total issues for all categories: 2.7;
Average size: 18,411.
Category: Public facilities;
Total amount: 14,650,700;
Percentage of total amount for all categories: 3.8;
Total issues: 661;
Percentage of total issues for all categories: 5.2;
Average size: 22,164.
Category: Libraries/museums;
Total amount: 867,400;
Percentage of total amount for all categories: 0.2;
Total issues: 71;
Percentage of total issues for all categories: 0.6;
Average size: 12,217.
Category: Government offices;
Total amount: 2,968,200;
Percentage of total amount for all categories: 0.8;
Total issues: 121;
Percentage of total issues for all categories: 1.0;
Average size: 24,531.
Category: Fire stations;
Total amount: 366,700;
Percentage of total amount for all categories: 0.1;
Total issues: 93;
Percentage of total issues for all categories: 0.7;
Average size: 3,943.
Category: Jails/prisons;
Total amount: 1,418,900;
Percentage of total amount for all categories: 0.4;
Total issues: 62;
Percentage of total issues for all categories: 0.5;
Average size: 22,885.
Category: Police stations;
Total amount: 558,700;
Percentage of total amount for all categories: 0.1;
Total issues: 16;
Percentage of total issues for all categories: 0.1;
Average size: 34,919.
Category: Convention centers;
Total amount: 2,443,100;
Percentage of total amount for all categories: 0.6;
Total issues: 57;
Percentage of total issues for all categories: 0.4;
Average size: 42,861.
Category: Stadiums/arenas;
Total amount: 3,996,300;
Percentage of total amount for all categories: 1.0;
Total issues: 31;
Percentage of total issues for all categories: 0.2;
Average size: 128,913.
Category: Theaters;
Total amount: 311,000;
Percentage of total amount for all categories: 0.1;
Total issues: 7;
Percentage of total issues for all categories: 0.1;
Average size: 44,429.
Category: Parks/zoos/ beaches;
Total amount: 824,800;
Percentage of total amount for all categories: 0.2;
Total issues: 132;
Percentage of total issues for all categories: 1.0;
Average size: 6,248.
Category: Other recreation;
Total amount: 895,600;
Percentage of total amount for all categories: 0.2;
Total issues: 71;
Percentage of total issues for all categories: 0.6;
Average size: 12,614.
Category: Transportation;
Total amount: 42,344,000;
Percentage of total amount for all categories: 10.9;
Total issues: 519;
Percentage of total issues for all categories: 4.1;
Average size: 81,588.
Category: Airports;
Total amount: 8,245,900;
Percentage of total amount for all categories: 2.1;
Total issues: 105;
Percentage of total issues for all categories: 0.8;
Average size: 78,532.
Category: Seaports;
Total amount: 3,008,500;
Percentage of total amount for all categories: 0.8;
Total issues: 48;
Percentage of total issues for all categories: 0.4;
Average size: 62,677.
Category: Toll roads;
Total amount: 14,576,500;
Percentage of total amount for all categories: 3.8;
Total issues: 222;
Percentage of total issues for all categories: 1.7;
Average size: 65,660.
Category: Bridges;
Total amount: 2,127,400;
Percentage of total amount for all categories: 0.5;
Total issues: 13;
Percentage of total issues for all categories: 0.1;
Average size: 163,646.
Category: Tunnels;
Total amount: 0;
Percentage of total amount for all categories: 0.0;
Total issues: 0;
Percentage of total issues for all categories: 0.0;
Average size: 0.
Category: Parking facilities;
Total amount: 510,600;
Percentage of total amount for all categories: 0.1;
Total issues: 49;
Percentage of total issues for all categories: 0.4;
Average size: 10,420.
Category: Mass transit;
Total amount: 13,875,000;
Percentage of total amount for all categories: 3.6;
Total issues: 81;
Percentage of total issues for all categories: 0.6;
Average size: 171,296.
Category: Other;
Total amount: 100;
Percentage of total amount for all categories: 0.0;
Total issues: 1;
Percentage of total issues for all categories: 0.0;
Average size: 100.
Category: Utilities;
Total amount: 42,014,500;
Percentage of total amount for all categories: 10.8;
Total issues: 1,328;
Percentage of total issues for all categories: 10.4;
Average size: 31,637.
Category: Water/sewer;
Total amount: 28,715,400;
Percentage of total amount for all categories: 7.4;
Total issues: 1,153;
Percentage of total issues for all categories: 9.1;
Average size: 24,905.
Category: Gas works;
Total amount: 10,741,700;
Percentage of total amount for all categories: 2.8;
Total issues: 27;
Percentage of total issues for all categories: 0.2;
Average size: 397,841.
Category: Telephone;
Total amount: 148,500;
Percentage of total amount for all categories: 0.0;
Total issues: 9;
Percentage of total issues for all categories: 0.1;
Average size: 16,500.
Category: Sanitation;
Total amount: 737,600;
Percentage of total amount for all categories: 0.2;
Total issues: 59;
Percentage of total issues for all categories: 0.5;
Average size: 12,502.
Category: Flood control;
Total amount: 620,000;
Percentage of total amount for all categories: 0.2;
Total issues: 24;
Percentage of total issues for all categories: 0.2;
Average size: 25,833.
Category: Combined utilities;
Total amount: 1,051,300;
Percentage of total amount for all categories: 0.3;
Total issues: 56;
Percentage of total issues for all categories: 0.4;
Average size: 18,773.
Category: General purpose;
Total amount: 86,711,000;
Percentage of total amount for all categories: 22.3;
Total issues: 3,526;
Percentage of total issues for all categories: 27.7;
Average size: 24,592.
Category: General purpose;
Total amount: 86,449,400;
Percentage of total amount for all categories: 22.2;
Total issues: 3,518;
Percentage of total issues for all categories: 27.6;
Average size: 24,573.
Category: Veterans;
Total amount: 203,800;
Percentage of total amount for all categories: 0.1;
Total issues: 1;
Percentage of total issues for all categories: 0.0;
Average size: 203,800.
Category: Places of worship;
Total amount: 47,900;
Percentage of total amount for all categories: 0.0;
Total issues: 5;
Percentage of total issues for all categories: 0.0;
Average size: 9,580.
Category: Agriculture;
Total amount: 9,900;
Percentage of total amount for all categories: 0.0;
Total issues: 2;
Percentage of total issues for all categories: 0.0;
Average size: 4,950.
Category: Total;
Total amount: $388,558,900;
Percentage of total amount for all categories: 100.0;
Total issues: 12,731;
Percentage of total issues for all categories: 100.0;
Average size: $30,521.
Source: GAO analysis of Thomson Financial data in the 2007 Bond Buyer
Yearbook.
[End of table]
As shown in table 2, the majority of municipal bonds issued in calendar
year 2006, both in terms of dollar amounts and numbers of bonds, fell
in the education and general purpose categories. Bonds categorized for
education-related purposes accounted for over 27 percent of the total
amount issued and about one-third of the number of bonds issued that
year. Bonds in the general purpose category accounted for over 22
percent of the total dollar amount and more than one-quarter of the
number of bonds issued during 2006. In addition, nearly one-fourth of
the total number of bonds issued in calendar year 2006 was categorized
only as general purpose in the subcategory of the general purpose
category. For these bonds, it is not clear what activities or
facilities were funded by the $86.5 billion of bonds.
Bonds placed into the transportation and electric power categories were
the largest bonds, averaging $81.6 million and $72.9 million,
respectively, per bond issue. The Long Island (New York) Power
Authority issued the largest bond in the electric power category in
2006 for $950 million, which included about $100 million for capital
improvements to things like power transmission lines, substations, and
transformers, and about $850 million for refunding purposes. The
largest transportation bond in 2006 was a $2.0 billion mass transit
bond sale by the Hudson Yards Infrastructure Corporation, New York, for
the extension of a subway line that is part of an effort to redevelop
the Hudson Yards area of midtown Manhattan. Bonds categorized by the
Bond Buyer Yearbook as development and public facilities, on average,
were the smallest bonds, averaging $12.6 million and $22.2 million,
respectively.
Appendix III shows information on the uses of municipal bonds from the
Bond Buyer Yearbook for the 5-year period of 2002 through 2006
combined.
Uses of Governmental Bonds Based on IRS's SOI Data and a Limited Random
Sample of Official Statements:
To provide information on the facilities and activities financed with
governmental bonds, we reviewed two data sources: (1) IRS's SOI tax-
exempt bond publications and database for 2002 though 2005 and (2) a
limited sample of official statements that MSRB received in 2006.
IRS's SOI categorizes information on governmental bonds into eight
broad categories. Unlike the Thomson Financial data, the SOI data do
not further categorize bonds into subcategories by purpose. For 2005,
the education and the other categories were the two largest categories
measured by dollar amount and total number of bonds issued.
Governmental bonds issued for transportation and education had the
largest average size per issue, $20.6 million and $11.4 million,
respectively. Figure 5 summarizes the dollar amounts and numbers of new
money, long-term governmental bonds issued in 2005 by the eight SOI
purpose categories. (See app. IV for similar data for the 5-year period
of 2001 through 2005.)
Figure 5: Dollar Amount and Number of New Money, Long-term Governmental
Bonds Issued in 2005 by IRS SOI Purpose Categories:
This figure is a combination bar and line graph showing the dollar
amount and number of new money, long-term governmental bonds issued in
2005 by IRS SOI purpose categories. The X axis represents the purpose
categories, the left Y axis represents the dollar amount issued:
Nominal 2005 dollars (in billions), and the right Y axis represents the
number of bonds issued. The bar represents the dollar amount issued,
and the line represents the number of bonds issued.
[See PDF for image]
Source: GAO analysis of IRS's Statistics of Income data.
[End of figure]
As shown in figure 5, based on IRS data, nearly $45.7 billion of the
new money, long-term governmental bonds issued in 2005 are classified
in the other category. This amounts to nearly one-third of all long-
term new money tax-exempt governmental bonds issued in 2005. Bond
issuers may provide additional information that describes their bond
issues if they classify their bonds in the "other" category. Because
IRS transcribes this information in its tax-exempt bond database, we
conducted a limited analysis of it to obtain information on the types
of activities and facilities that are included in the other
category.[Footnote 17]
Among other things, our analysis showed that bonds in the other
category were issued for a wide range of purposes, reflecting the broad
discretion that state and local governments have in determining what
facilities and projects to finance with tax-exempt bonds. We found that
bonds in the other category were issued to finance industrial parks,
arenas, stadiums, parking facilities, sidewalks, golf courses, general
government operations, public recreation facilities, land, vehicles,
computer hardware, and various other purposes. While we found that the
facilities and activities financed with some bonds were apparent in
many cases, they were not as obvious in some other cases, such as when
"various government operations" and similar descriptions were provided.
However, our limited review does not provide a comprehensive list of
the facilities and activities being financed with governmental bonds
classified in IRS's other category.
While the Thomson Financial and SOI data provide aggregate data on the
projects financed with tax-exempt bonds, the official statements for
the bonds often provide more detailed information on the uses of the
bonds. Because of this, we reviewed a limited random sample of official
statements of governmental bonds to provide examples of the types of
descriptive information they contain on the projects financed with the
bonds. The sample was drawn from official statements MSRB received in
calendar year 2006. In total, the sample consists of 40 bonds--5 bonds
that we identified that would likely be classified into each of the
eight SOI categories for governmental bonds.[Footnote 18] The sample is
not generalizable--meaning it cannot be used to generate estimates
about all governmental bonds issued in 2006. Instead, it provides a
limited number of specific examples of projects and activities that
were financed with governmental bonds. Table 3 shows descriptions of
the uses of bonds based on our analysis of official statements. (The
methodology for our sample is discussed in app. I.)
Table 3: Summary of Facilities and Activities Financed with Tax-Exempt
Bonds Issued in 2006 Based on a Limited Sample of 40 Official
Statements:
Bond category: Education (5 bonds);
Description of bond use: * Construction of university track and field
stadium;
* Construction of schools;
* Construction of schools;
* Construction of schools;
* Shared computer, learning resources, and staff development services.
Bond category: Environment (5 bonds)[A];
Description of bond use: * Sewer and water facilities;
* Sewer and water facilities;
* Sewer and water facilities;
* Sewer and water facilities;
* Sewer and water facilities and pollution control.
Bond category: Health and hospital (5 bonds);
Description of bond use:
* Construction of new hospital and demolition of old hospital;
* Construction of health care facilities;
* Construction of new hospital;
* Improvements to existing hospital;
* Improvements to existing hospital.
Bond category: Housing (5 bonds);
Description of bond use: * Rehabilitate a housing development and
office space for the issuing authority;
* Construction of a continuing care retirement facility;
* Finance single-family residences for low-income families;
* Construction of a multifamily housing unit;
* Finance owner-occupied single-family residences.
Bond category: Public safety (5 bonds);
Description of bond use: * School fire prevention and safety purposes;
* Construction of courthouse and other public buildings, computer
equipment, and county vehicles;
* Construction of jail facility;
* Construction of county justice system building;
* Construction of two fire stations, emergency medical vehicles, and
equipment.
Bond category: Transportation (5 bonds);
Description of bond use: * Street improvements;
* Street improvements;
* Marina and other port- related projects;
* Street improvements;
* Street improvements.
Bond category: Utilities (5 bonds)[A];
Description of bond use: * Water system improvements;
* Water system improvements;
* Water system improvements;
* Water system improvements;
* Electric system improvements.
Bond category: Other (5 bonds);
Description of bond use: * Furnishings and equipment;
* Streets, sewers, and other public improvements;
* Various public works projects, including water and sewer systems,
electric systems, gas systems, airports, and other revenue-producing
public works projects;
* Various capital improvement projects and equipment, including city
trucks, police cars, water main extension, school renovations, and fire
department equipment;
* Construction of two YMCA facilities.
Source: GAO analysis of official statements received by MSRB in 2006.
Note: Some of the official statements we reviewed in each category were
for bonds that had similar purposes. As a result, some of the entries
in each category are identical.
[A] IRS Form 8038 instructs bond issuers to classify bonds for sewer
facilities as environment. As a result, we classified bonds that
indicated that they were for sewer and water facilities in the
environment category. Bonds only used for water system improvements
were classified in the utilities category.
[End of table]
As table 3 shows, in general, the official statements we reviewed were
for bonds with purposes traditionally associated with financing for
governmental bonds.
Uses of Private Activity Bonds Based on IRS's SOI Data:
Table 4 provides summary information on the uses of tax-exempt private
activity bonds issued in 2005 based on IRS's SOI data. As the table
illustrates, in 2005, section 501(c)(3) bonds, including those issued
for hospitals, accounted for over half of the dollar amount and number
of new money, long-term private activity bonds. Section 501(c)(3)
nonhospital bonds constituted the largest category of qualified private
activity bonds in 2005 (29 percent). As a percentage of all private
activity bonds, the section 501(c)(3) nonhospital bond category has
been larger in recent years than in the early 1990s.
If only new money long-term private activity bonds are considered,
section 501(c)(3) bonds for other than hospitals have risen from about
20 percent of private activity bonds in the early 1990s to nearly 30
percent yearly in 2003 through 2005. Since 1997, section 501(c)(3)
nonhospital bonds have accounted for more than 27 percent of new long-
term private activity bond amounts, with 4 peak years of 38 to 39
percent. Before 1997, section 501(c)(3) nonhospital bonds had never
accounted for more than 24 percent of the total amount of new money
private activity bonds issued annually. According to a Treasury
official, one possible explanation for the increase in 501(c)(3) bonds
as percentage of all qualified private activity bonds is that unlike
other qualified private activity bonds, 501(c)(3) bonds are not subject
to annual state volume caps.
Section 501(c)(3) bonds help finance construction of facilities and
other property used by charitable, educational, religious, and similar
organizations recognized as tax-exempt under section 501(c)(3) of the
I.R.C. and can generally only be used for projects that support the
charitable activities of the 501(c)(3) organization that is benefiting
from the bonds.[Footnote 19] Analysis of 2003 and 2004 SOI data for
"Qualified 501(c)(3) Nonhospital" bonds indicated that about 83 percent
of tax-exempt bond dollars in this category were used for the following
purposes: transportation (10.3 percent), construction (5.6 percent),
renting and leasing real estate (14.8 percent), education (15.4
percent), and health care (37.2 percent).[Footnote 20]
Table 4: Summary of Facilities and Activities Financed with New Money,
Long-term Tax-Exempt Private Activity Bonds Issued in 2005:
Nominal 2005 dollars in millions.
Airport;
Amount issued: $3,152;
Percentage of total amount: 5.8;
Number issued: 39;
Percentage of number issued: 1.5;
Average size: $80.8.
Docks and wharves;
Amount issued: 156;
Percentage of total amount: 0.3;
Number issued: 6;
Percentage of number issued: 0.2;
Average size: 26.0.
Water;
Amount issued: 189;
Percentage of total amount: 0.3;
Number issued: 14;
Percentage of number issued: 0.5;
Average size: 13.5.
Sewage;
Amount issued: 194;
Percentage of total amount: 0.4;
Number issued: 12;
Percentage of number issued: 0.5;
Average size: 16.2.
Solid waste disposal;
Amount issued: 1,464;
Percentage of total amount: 2.7;
Number issued: 57;
Percentage of number issued: 2.2;
Average size: 25.7.
Qualified residential rental;
Amount issued: 6,459;
Percentage of total amount: 11.8;
Number issued: 478;
Percentage of number issued: 18.5;
Average size: 13.5.
Local electricity or gas furnishing facilities;
Amount issued: 142;
Percentage of total amount: 0.3;
Number issued: 3;
Percentage of number issued: 0.1;
Average size: 47.3.
Local district heating or cooling facilities;
Amount issued: 24;
Percentage of total amount: 0.0;
Number issued: 3;
Percentage of number issued: 0.1;
Average size: 8.0.
Hydroelectric environmental facilities[A];
Amount issued: --;
Percentage of total amount: --;
Number issued: --;
Percentage of number issued: --;
Average size: --.
Tax Reform Act of 1986 transition property;
Amount issued: 125;
Percentage of total amount: 0.2;
Number issued: 5;
Percentage of number issued: 0.2;
Average size: 25.0.
District of Columbia enterprise zone[A];
Amount issued: --;
Percentage of total amount: --;
Number issued: --;
Percentage of number issued: -
-;
Average size: --.
Qualified new empowerment zone;
Amount issued: 232;
Percentage of total amount: 0.4;
Number issued: 10;
Percentage of number issued: 0.4;
Average size: 23.2.
New York liberty zone[A];
Amount issued: --;
Percentage of total amount: --;
Number issued: --;
Percentage of number issued: --;
Average size: --.
Qualified mortgage;
Amount issued: 6,602;
Percentage of total amount: 12.1;
Number issued: 145;
Percentage of number issued: 5.6;
Average size: 45.5.
Qualified veterans mortgage[A];
Amount issued: --;
Percentage of total amount: --;
Number issued: --;
Percentage of number issued: --;
Average size: --.
Qualified small issue;
Amount issued: 701;
Percentage of total amount: 1.3;
Number issued: 422;
Percentage of number issued: 16.3;
Average size: 1.7.
Qualified student loan;
Amount issued: 4,699;
Percentage of total amount: 8.6;
Number issued: 36;
Percentage of number issued: 1.4;
Average size: 130.5.
Qualified redevelopment[A];
Amount issued: --;
Percentage of total amount: --;
Number issued: --;
Percentage of number issued: --;
Average size: --.
Qualified Section 501(c)(3) hospital;
Amount issued: 12,224;
Percentage of total amount: 22.4;
Number issued: 288;
Percentage of number issued: 11.1;
Average size: 42.4.
Qualified Section 501(c)(3) nonhospital;
Amount issued: 15,745;
Percentage of total amount: 28.8;
Number issued: 1,080;
Percentage of number issued: 41.8;
Average size: 14.6.
Nongovernmental output property[A];
Amount issued: --;
Percentage of total amount: --;
Number issued: --;
Percentage of number issued: --;
Average size: --.
Other purposes[B];
Amount issued: 31;
Percentage of total amount: 0.1;
Number issued: 13;
Percentage of number issued: 0.5;
Average size: 2.4.
Total[C];
Amount issued: $54,691;
Percentage of total amount: 100.0;
Number issued: 2,586;
Percentage of number issued: 100.0;
Average size: $21.1.
Source: GAO analysis of IRS's Statistics of Income Division data.
[A] Based on SOI data, these cells are blank to avoid disclosure of
information about specific bonds. However, the data are included in the
appropriate totals.
[B] For this table, other purposes refers to obligations for which a
specific purpose either did not apply or was not clearly indicated on
the Form 8038.
[C] A given bond issue can include more than one purpose. As a result,
when added together, the number of issues for each individual purpose
is greater than the total number of bonds issued. In addition, the
amounts issued and number of bonds issued may not equal the total
because the amounts in the individual cells are rounded.
[End of table]
Recently, Congress has enacted legislation creating new types of tax-
exempt private activity bonds. Table 5 provides a summary of the new
types of tax-exempt private activity bonds enacted since 2001.
Table 5: New Types of Private Activity Bonds Created since 2001:
Type: Public education[A];
Year authorized: 2001;
Volume authorized (dollars in millions): $15,000;
Purpose and examples of authorized uses: For public-private
partnerships between school districts and private developers;
* Authorized uses include school buildings, athletic facilities, and
property used in connection with the school facility.
Type: New York Liberty Zone[B];
Year authorized: 2002;
Volume authorized (dollars in millions): $8,000;
Purpose and examples of authorized uses: For economic development and
rebuilding in designated areas of New York City after 9/11;
* Authorized uses include financing the construction and rehabilitation
of nonresidential and residential real property.
Type: Green building[C];
Year authorized: 2004;
Volume authorized (dollars in millions): $2,000;
Purpose and examples of authorized uses: For the development of energy-
efficient buildings and their surrounding landscapes;
* Authorized uses include commercial buildings meeting certain
standards or including a brownfield site-- sites being redeveloped that
may contain pollutants or other contaminants.
Type: Highway and surface freight transfer[D];
Year authorized: 2005;
Volume authorized (dollars in millions): $15,000;
Purpose and examples of authorized uses: For financing for certain
projects to transfer freight from trucks to rail cars or vice versa;
* Authorized uses include international bridges or tunnels, cranes,
loading docks, and computer-controlled equipment.
Type: Gulf Opportunity Zone[E];
Year authorized: 2005;
Volume authorized (dollars in millions): $14,800;
Purpose and examples of authorized uses: For assistance to support
areas affected by hurricanes Katrina, Wilma and Rita;
* Authorized uses include office buildings, hotels, retail stores,
warehouses, manufacturing, medical, and other commercial facilities.
Sources: GAO analysis and Congressional Research Service.
[A] Pub. L. No. 107-16 (2001).
[B] Pub. L. No. 107-147 (2002) and Pub. L. No. 108-311 (2004).
[C] Pub. L. No. 108-357 (2004).
[D] Pub. L. No. 109-59 (2005).
[E] Pub. L. No. 109-135 (2005).
[End of table]
Governmental Bonds Can Be Used to Finance Certain Projects That
Generally Cannot Be Financed with Qualified Private Activity Bonds:
Over the last several decades, Congress has prohibited qualified
private activity bonds from being used to finance certain projects. For
example, the Tax Reform Act of 1986[Footnote 21] prohibited the use of
qualified private activity bonds to finance a number of specific
facilities, including hotels adjacent to airports, professional sports
stadiums, and private golf courses.[Footnote 22] Although qualified
private activity bonds can no longer be used to finance such
facilities, these types of facilities can be financed with tax-exempt
governmental bonds because, as previously discussed, they fail either
the private payments or private business use test. In addition,
governmental bonds could be issued by authorities that directly operate
facilities, such as golf courses, that qualify as general public use.
Under current law, state and local governments have broad discretion to
make decisions on the types of projects and activities they finance
with tax-exempt bonds. Further, while the 1986 act prohibited qualified
private activity bonds from being used to finance certain projects such
as hotels, Congress did not prohibit such projects from being financed
with governmental bonds. According to legislative history surrounding
the 1986 change, Congress directed Treasury to liberalize guidelines
regarding the treatment of third-party use pursuant to management
agreements.[Footnote 23] The liberalization of the guidelines has
permitted governmental entities to use third parties to operate
facilities financed with tax-exempt governmental bonds under management
agreements so that the third-party use of the bond-financed property is
not treated as a private trade or business.
Generally, the guidelines issued by Treasury in Revenue Procedure 97-
13[Footnote 24] provide that tax-exempt governmental bonds can be used
to finance certain facilities provided ownership of the facility
remains with the governmental entity issuing the bonds and that
payments to the facility operator are not based on the facility's net
profits. The facility operator may be compensated based on the gross
operating revenues of the facility, a per unit fee, or a per person
fee.
As you requested, we are providing information on newly constructed
hotels and golf courses that were recently financed, at least in part,
with some amount of tax-exempt bonds. Our information is limited
because we could not identify any comprehensive lists of hotels and
municipal golf courses that were financed with tax-exempt bonds.
Neither the Bond Buyer Yearbook nor the SOI data had information on
hotels and golf courses that were financed with tax-exempt
bonds.[Footnote 25] We considered recent years for our analysis because
information on financing would more likely be available than
information for facilities financed in earlier years. For hotels, we
limited our analysis to hotels that were financed with tax-exempt bonds
issued from 2002 through 2006, and for golf courses we limited our
analysis to municipal courses that opened in 2005. We found 18 hotels
and 6 golf courses that we could confirm had some tax-exempt bond
financing in those years.
In general, the hotels were large, full-service hotels. Not all the
hotels were yet rated by the American Automobile Association
(AAA),[Footnote 26] but those with AAA ratings were all three-or four-
diamond hotels, meaning that at a minimum the hotels provided
multifaceted, comprehensive services and, in the case of four-diamond
hotels, were considered upscale with extensive amenities. In 14 of the
18 cases, the hotels contained conference facilities or were located
near convention centers. According to the official statements, the
hotels that were built in connection with convention centers were
usually intended to enhance the competitive position of convention
center facilities, making the convention center a more appealing and
convenient location to hold large meetings, and to contribute to
economic development in the areas where they are being built. Table 6
summarizes information on the hotels we identified.
Table 6: New Hotels Financed with Tax-Exempt Governmental Bonds Issued
from 2002 through 2006:
Year bond issued: 2002;
Hotel location: Bay City, MI;
Issuer type: City-created nonprofit corporation;
Amount[A]: $15,455,000;
Bond type[B]: Revenue;
General description[C]: A 150-room, three- diamond Doubletree hotel and
conference center in downtown area.
Year bond issued: 2002;
Hotel location: Omaha, NE;
Issuer type: City- created nonprofit corporation;
Amount[A]: $102,970,000;
Bond type[B]: Revenue;
General description[C]: A 450-room, four-diamond Hilton hotel adjacent
to Omaha convention center and arena.
Year bond issued: 2002;
Hotel location: Louisville, KY;
Issuer type: Local government;
Amount[A]: $38,900,000;
Bond type[B]: General obligation;
General description[C]: A 616-room, four-diamond Marriott hotel next to
convention center in downtown area.
Year bond issued: 2002;
Hotel location: Washington, DC;
Issuer type: Local government;
Amount[A]: $45,995,387;
Bond type[B]: Tax increment financing;
General description[C]: A 400-room, four-diamond Mandarin hotel and
conference center.
Year bond issued: 2002;
Hotel location: Hollywood, FL[D];
Issuer type: Local authority;
Amount[A]: $469,000,000;
Bond type[B]: Revenue;
General description[C]: A 250-room, four-diamond Hard Rock hotel and
resort facility in Hollywood, FL, attached to a casino on the Seminole
Indian Reservation.
Year bond issued: 2002;
Hotel location: Tampa, FL[D];
Issuer type: Local authority;
Amount[A]: $469,000,000;
Bond type[B]: Revenue;
General description[C]: A 250-room, four-diamond Hard Rock hotel and
resort facility in Tampa, FL, attached to a casino on the Seminole
Indian Reservation.
Year bond issued: 2003;
Hotel location: Vancouver, WA;
Issuer type: Local authority;
Amount[A]: $65,855,000;
Bond type[B]: Revenue;
General description[C]: A 226-room, three-diamond Hilton hotel and
conference center in downtown area.
Year bond issued: 2003;
Hotel location: Denver, CO;
Issuer type: City- created nonprofit corporation;
Amount[A]: $354,825,000;
Bond type[B]: Revenue;
General description[C]: A 1,100-room, four-diamond Hyatt Regency hotel
next to convention center.
Year bond issued: 2004;
Hotel location: Montebello, CA[E];
Issuer type: Local authority;
Amount[A]: $17,060,000;
Bond type[B]: Revenue;
General description[C]: A 121-room, three-diamond Hilton Garden Inn
hotel next to country club and banquet facility.
Year bond issued: 2004;
Hotel location: Schaumburg, IL;
Issuer type: Local government;
Amount[A]: $239,320,000;
Bond type[B]: General obligation;
General description[C]: A 500-room, four-diamond Renaissance hotel next
to convention center.
Year bond issued: 2005;
Hotel location: Raleigh, NC;
Issuer type: Local government;
Amount[A]: $216,940,000;
Bond type[B]: Certificates of participation;
General description[C]: A 400-room, three-diamond Marriott hotel
adjacent to convention center.
Year bond issued: 2005;
Hotel location: New Brunswick, NJ;
Issuer type: Local authority;
Amount[A]: $30,000,000;
Bond type[B]: Revenue;
General description[C]: A 248-room, three-diamond Heldrich hotel, part
of a mixed-use facility near Rutgers University.
Year bond issued: 2005;
Hotel location: Shreveport, LA;
Issuer type: Local authority;
Amount[A]: $40,000,000;
Bond type[B]: Revenue;
General description[C]: A 313-room Hilton hotel next to convention
center complex.
Year bond issued: 2005;
Hotel location: San Antonio, TX;
Issuer type: City-created nonprofit corporation;
Amount[A]: $129,930,000;
Bond type[B]: Revenue;
General description[C]: A 1,000-room Hyatt hotel next to convention
center.
Year bond issued: 2005;
Hotel location: Erie, PA;
Issuer type: Local authority;
Amount[A]: $45,390,000;
Bond type[B]: Revenue;
General description[C]: A 200-room waterfront Sheraton hotel next to
convention center.
Year bond issued: 2005;
Hotel location: Phoenix, AZ;
Issuer type: City- created nonprofit corporation;
Amount[A]: $156,710,000;
Bond type[B]: Revenue;
General description[C]: A 1,000-room Sheraton hotel located downtown
next to convention center.
Year bond issued: 2005;
Hotel location: Lombard, IL;
Issuer type: City- created nonprofit corporation;
Amount[A]: $161,250,000;
Bond type[B]: Revenue;
General description[C]: A 500-room conference center Westin hotel in
the Chicago suburbs.
Year bond issued: 2006;
Hotel location: Baltimore, MD;
Issuer type: Local government;
Amount[A]: $300,940,000;
Bond type[B]: Revenue;
General description[C]: A 757-room Hilton hotel adjacent to convention
center located downtown.
Source: GAO analysis of financial reports of municipalities and
documents from Orrick, Herrington, and Sutcliffe LLP; HVS
International; Akin Gump Strauss Hauer & Feld LLP; and Piper Jaffray
and official statements from MSRB.
[A] The amount of bond proceeds for each bond is not necessarily equal
to the total cost of the project. Some hotel financings have generated
funds from multiple sources.
[B] Bonds received investment grade rankings from bond rating services.
[C] The number of diamonds is the AAA rating for the quality of the
hotel. Not all hotels we identified have received AAA ratings.
[D] The Hard Rock Hotel Projects in Hollywood and Tampa, Florida, did
not provide separate financing breakout per location. In addition, the
number of hotel rooms financed was 250 of a total of 750 rooms at the
locations.
[E] The bond issued in 2004 was a partial refunding for a bond
previously issued in 2001 for construction of the hotel.
[End of table]
In general, the six golf courses we identified and confirmed as being
constructed, at least in part, with tax-exempt governmental bond
financing were considered among the better golfing facilities in their
respective regions. For example, in 2006, Golf Styles magazine
recognized the Lorton, Virginia, course as one of the "100 Must Play
Courses of the Middle Atlantic." Additionally, Golf Digest recognized
the publicly financed course in Patterson, Louisiana, as one of the
best new public courses in 2006. Table 7 provides information on the
municipal golf courses we identified.
Table 7: Municipal Golf Courses Opened in 2005 and Financed with Tax-
Exempt Governmental Bonds:
Year bond issued: 2003;
Golf course location: Pleasanton, CA;
Issuer type: City-created nonprofit corporation;
Amount[A]: $28,425,000;
Bond type[B]: Certificates of participation;
General description: An 18-hole Callippe Preserve Golf Course rated as
one of the top 10 in California and one of the best new public courses
in 2006, and recognized for environmental excellence by the Audubon
Cooperative Sanctuary System (green fees range between $36 and $52).
Year bond issued: 2003;
Golf course location: Lorton, VA;
Issuer type: Local authority;
Amount[A]: $15,530,000;
Bond type[B]: Revenue;
General description: An 18-hole Laurel Hill Golf Club located on the
grounds of the former Lorton Correctional Facility (green fees range
between $74 and $89).
Year bond issued: 2003;
Golf course location: Fargo, ND;
Issuer type: Local government;
Amount[A]: $3,065,000;
Bond type[B]: Certificates of participation;
General description: A 9-hole Osgood Golf Course with 3-hole
developmental facility (green fees range between $13.50 and $15).
Year bond issued: 2002;
Golf course location: La Quinta, CA;
Issuer type: Local authority;
Amount[A]: $103,760,000[C];
Bond type[B]: Tax increment financing;
General description: An 18-hole Arnold Palmer Classic Silver Rock
Resort golf course (green fees range between $145 and $160).
Year bond issued: 2002;
Golf course location: Patterson, LA;
Issuer type: Local authority;
Amount[A]: $3,000,000;
Bond type[B]: General obligation;
General description: An 18-hole Atchafalaya at Idlewild Golf Course
rated as one of the top 10 in Louisiana and rated as one of the best
new public courses in 2006 (green fees range between $55 and $65).
Year bond issued: 2003;
Golf course location: Norfolk, VA;
Issuer type: Local government;
Amount[A]: $9,050,000;
Bond type[B]: General obligation;
General description: A 9-hole executive Lamberts Point Golf Course
constructed on a former landfill. Winner of the Affinity Award for best
environmental project at the 2006 Golf Course News Builder Excellence
Awards (green fees range between $18 and $20).
Source: GAO analysis of National Golf Foundation data and official
statements from MSRB.
[A] The amount of bond proceeds for each bond is not necessarily equal
to the total cost of the project. Some golf course financings are part
of a larger project, and some are constructed using funds from multiple
sources.
[B] All bonds received investment grade rankings from bond rating
services.
[C] Amount denotes a total of three bonds issued to fund a project that
includes the golf course, and the information we reviewed did not
specifically disclose the amount of financing dedicated only to the
golf course.
[End of table]
While tax-exempt governmental bonds are typically used to support
traditional governmental functions with a public purpose, they are
sometimes used for activities that are essentially private in nature,
as illustrated by the hotels and golf courses we identified. Municipal
governments have used their broad discretion to finance projects and
activities, such as hotels, that are essentially private with tax-
exempt governmental bonds on the grounds that the facilities and
activities serve broader public purposes. Broader public purposes may
include providing benefits to a community that extend beyond the
purpose of the facility being financed by the bonds or providing
certain services to those who would not otherwise be able to use them.
It is not clear whether facilities like these provide public benefits
to federal taxpayers that extend beyond the purposes of the facilities.
The state and local governments that issued the bonds to finance hotels
and golf courses generally justified the projects on the grounds that
they would generate economic development, including new jobs and
businesses. However, in some cases, it is not clear whether the
facilities generate public benefits that would be underprovided by the
private market or whether the facilities generally make services
available to those who would not otherwise be able to use them. For
example, in 2005, about 85 percent of existing golf courses had been
financed privately, offering a range of fees and services often similar
to those offered by publicly financed courses. As a result, the use of
tax-exempt governmental bonds for facilities and activities like hotels
and golf courses, which are routinely financed with private funds,
raises questions about how much public benefit is produced at the local
level and what, if any, benefits federal taxpayers receive for
subsidizing these and other kinds of facilities that are essentially
private in nature.
The House Committee on Oversight and Government Reform's Subcommittee
on Domestic Policy recently held hearings that focused primarily on
whether tax-exempt governmental bonds should be used to finance
professional sports stadiums that are privately used.[Footnote 27] In
1986, Congress removed sports stadiums, along with other facilities,
including certain hotels and golf courses, from the list of facilities
eligible for tax-exempt private activity bond financing. Participants
in congressional hearings leading up to the restrictions placed on tax-
exempt private activity bonds in 1986 debated allowing stadiums and
other facilities that were routinely financed with private funds from
being financed with tax-exempt private activity bonds. However,
stadiums and other facilities, including hotels and golf courses,
continue to be financed with tax-exempt governmental bonds if they
satisfy certain requirements for governmental bonds or safe harbors
pertaining to private use. For example, according to Treasury's
Assistant Secretary for Tax Policy, under current law, the requirements
to use governmental bonds for stadiums can generally be met when state
and local governments subsidize the projects with governmental revenues
or governmental sources of funds, such as generally applicable taxes.
He also stated that from a tax policy perspective, the ability to use
governmental bonds to finance stadiums with significant private
business use when the bonds are subsidized with state or local
governmental payments possibly represents a weakness in the targeting
of the federal subsidy for tax-exempt bonds under the existing legal
framework. A similar situation may exist with the continued financing
of hotels and golf courses using tax-exempt governmental bonds.
Borrowing Costs Vary Depending on Bond Characteristics, and Some Bonds
Appear to Exceed the Statutory Limit on Issuance Costs Paid from Bond
Proceeds:
Borrowing costs paid by bond issuers include interest and issuance
costs. Although study results varied, most studies that we reviewed
indicate that bonds sold through competitive sales generally have lower
interest costs than bonds sold through negotiated sales after taking
other factors into account that might influence interest costs. Median
issuance costs paid from bond proceeds as a percentage of bond proceeds
vary by the size and type of tax-exempt bond. Slightly over half of the
qualified private activity bonds issued from 2002 through 2005 had
issuance costs paid from bond proceeds--with nearly half leaving the
reporting line blank--and some of the bonds had issuance costs that
exceeded statutory limits. For example, from 2002 to 2005, between 17
and 39 qualified private activity bonds annually--about 1 to 2 percent
of qualified private activity bonds that reported issuance costs paid
from bond proceeds--reported issuance costs that exceeded applicable
statutory limits.
Although Study Results Varied, Most Studies Generally Found That
Competitive Bond Sales Have Lower Interest Costs after Controlling for
Other Factors:
Researchers have attempted to determine whether the method of sale
(i.e., competition between underwriters or negotiation with
underwriters) has an effect on the interest costs that bond issuers pay
investors. From the federal government's perspective, lower interest
costs for municipal governments may be preferable because this might
result in less forgone federal tax revenue and better target the
subsidy to its intended beneficiaries. However, even if the competed
method of sale generally yields lower interest costs to municipal
governments, the negotiated method of sale may still be preferable in
some instances.[Footnote 28] We reviewed studies published from 1996
through 2007 that address whether there is a difference in interest
costs for bonds sold on a competitive basis versus bonds sold on a
negotiated basis.
The studies we reviewed generally used statistical analysis
techniques[Footnote 29] to identify the effect that the method of sale
(i.e., competitive or negotiated) has on the interest cost paid by bond
issuers. In addition to the method of sale, a number of other factors
in the municipal bond market could affect interest costs, and the
studies we reviewed attempt to control for these factors to isolate the
effect that the method of sale has on interest costs. Other factors
that could affect a bond issuer's borrowing costs include marketwide
factors, such as the average level of tax-exempt interest rates and the
recent volatility of these rates; issuer-specific factors, such as
economic characteristics of the issuing jurisdiction and the amount of
experience the issuer has in issuing bonds; and bond-specific factors,
such as the number of years until the bond matures, the amount of the
bond, the purpose of the bond, the funding source that backs the bond,
the bond's credit rating, and whether the issuer purchased bond
insurance or other credit enhancers.
In general, after controlling for other factors that may affect
interest costs, research suggests that bonds issued on a competitive
basis will likely have lower interest costs than bonds sold on a
negotiated basis because bond issuers are likely to benefit from
multiple underwriters bidding on the right to sell the bonds.[Footnote
30] In addition, several of the studies suggested that as the number of
competitive bids on a bond issue increase, the interest costs that
state and local governments pay decline further. However, one of the
studies we reviewed found no significant differences in interest costs
for competitive and negotiated sales and one found some advantage for
negotiated bonds.[Footnote 31]
The studies included in our literature review had several limitations.
Because of limited data availability, some key variables are not
available to be included in the study. No study that we reviewed had
data on the extent to which issuers that used a negotiated sale
searched among several underwriters before making a selection. Also,
none of the studies we reviewed included a comprehensive, recent review
of competitive and negotiated bond sales for the entire municipal bond
market. Most of the studies we identified were limited to certain
states for certain time periods or focused on a particular market
sector, such as bonds issued specifically for hospitals.
See appendix V for a list of the studies we reviewed addressing whether
interest costs vary by method of bond sale.
Some Qualified Private Activity Bond Issuers Reported Issuance Costs
Exceeding Legal Limits, and Issuance Costs Vary Depending on Bond
Characteristics:
IRS requires qualified private activity bond issuers to report issuance
costs paid from bond proceeds on the Form 8038, and for most types of
private activity bonds, issuance costs that can be paid from bond
proceeds are limited to 2 percent of bond proceeds.[Footnote 32] From
2002 to 2005, bond issuers reported issuance costs paid from bond
proceeds on slightly more than half of the filed Form 8038s. For
example, bond issuers reported issuance costs paid from bond proceeds
between 51 percent and 59 percent of the time annually for 2002 to
2005. Bond issuers for the remaining bonds left the line for issuance
costs paid from bond proceeds blank. Issuers of smaller bonds, meaning
those with bond proceeds of less than $1 million, reported issuance
costs less frequently than issuers of larger bonds; however, issuers of
large bonds, meaning those with proceeds over $100 million, also did
not report issuance costs about 35 percent of the time.
According to the Director of IRS's Tax-Exempt Bond Office, IRS would
need to contact the issuer to determine whether a tax-exempt bond
information return that a bond issuer submitted to IRS reporting no
issuance cost is a problem. He said that there may be legitimate
reasons why issuance cost was not reported on the form, such as when
issuance costs are paid from other sources or special funds. Currently,
IRS does not have mechanisms in place to routinely determine whether
unreported issuance cost is a compliance problem or a bond issuer's
mistake. IRS's instructions for Form 8038 require bond issuers to enter
the amount of proceeds that will be used to pay bond issuance costs,
including underwriters' spread and fees for trustees and bond counsel.
However, the instructions do not provide any guidance for instances
when issuance costs are not paid from bond proceeds.
For qualified private activity bonds with reported issuance costs, the
median issuance costs as a percentage of bond proceeds varied by the
size and type of the bond. For all qualified private activity bonds
that reported issuance costs paid from bond proceeds, the median
issuance cost as a percentage of bond proceeds ranged from a low of 1.6
percent in 2005 to a high of 1.8 percent in 2002. For bonds under $10
million, the median issuance cost as a percentage of bond proceeds
reached or came close to the 2 percent limit annually from 2002 to
2005. Larger bonds reported lower issuance costs as a percentage of
bond proceeds, possibly indicating that issuance costs include fixed
fees or other payments that are not based on the size of the bond. When
considering bond purposes, the median issuance costs as a percentage of
bond proceeds for qualified private activity bonds issued reached or
came near the 2 percent statutory limit for numerous categories of
bonds. Table 8 shows median issuance costs paid from bond proceeds as a
percentage of bond proceeds for long-term qualified private activity
bonds issued from 2002 to 2005.
Table 8: Median Issuance Costs Paid from Bond Proceeds as a Percentage
of Bond Proceeds for Long-term Qualified Private Activity Bonds Issued
from 2002 to 2005:
All;
2002: 1.81;
2003: 1.77;
2004: 1.69;
2005: 1.64.
Purpose: Airport;
2002: 1.17;
2003: 1.36;
2004: 1.30;
2005: 1.13.
Purpose: Docks;
2002: 1.17;
2003: 1.38;
2004: 1.70;
2005: 0.90.
Purpose: Water;
2002: 1.64;
2003: 2.00;
2004: 1.89;
2005: 1.89.
Purpose: Sewage;
2002: 1.99;
2003: 2.00;
2004: 2.00;
2005: 1.99.
Purpose: Solid waste;
2002: 2.00;
2003: 2.00;
2004: 2.00;
2005: 1.81.
Purpose: Rental;
2002: 1.89;
2003: 1.76;
2004: 1.75;
2005: 1.61.
Purpose: Mortgage revenue[A];
2002: 1.00;
2003: 1.01;
2004: 1.06;
2005: 0.71.
Purpose: Small issue;
2002: 2.00;
2003: 2.00;
2004: 2.00;
2005: 2.00.
Purpose: Student loan;
2002: 0.90;
2003: 0.61;
2004: 0.60;
2005: 0.63.
Purpose: Hospital;
2002: 1.28;
2003: 1.26;
2004: 1.15;
2005: 1.08.
Purpose: 501(c )(3);
2002: 1.89;
2003: 1.87;
2004: 1.81;
2005: 1.85.
Purpose: Other;
2002: 1.49;
2003: 1.86;
2004: 1.48;
2005: 1.44.
Size: Under $1 million;
2002: 2.00;
2003: 2.00;
2004: 2.00;
2005: 1.94.
Size: $1 million - under $10 million;
2002: 2.00;
2003: 2.00;
2004: 1.96;
2005: 1.99.
Size: $10 million - under $50 million;
2002: 1.66;
2003: 1.63;
2004: 1.63;
2005: 1.55.
Size: $50 million - under $100 million;
2002: 1.16;
2003: 1.16;
2004: 1.13;
2005: 1.08.
Size: $100 million and over;
2002: 0.90;
2003: 0.87;
2004: 0.83;
2005: 0.72.
Source: GAO analysis of IRS data.
Notes: In cases where the median issuance cost percentage is equal to
2, it means that at least half the bonds were at the statutory limit.
It does not mean that half of the bonds exceeded the 2 percent limit--
multiple bonds could be at the limit without exceeding it.
The size of the issue is measured in 2007 dollars. The percentages in
the table are calculated from forms where issuance costs paid from bond
proceeds were reported. Forms where issuers reported zero issuance
costs paid from bond proceeds or left the line blank are excluded from
these median calculations.
[A] Mortgage revenue and veterans' mortgage revenue bonds are combined
into one category. These bonds are subject to 3.5 percent limits for
issuance costs paid from bond proceeds.
[End of table]
Of the qualified private activity bonds with reported issuance costs,
we identified 38 bonds in 2002, 39 bonds in 2003, 25 bonds in 2004, and
17 bonds in 2005 that reported issuance costs as a percentage of bond
proceeds that exceeded statutory limits. This accounts for 1 to 2
percent of qualified private activity bonds issued annually.
According to the Director of IRS's Tax-Exempt Bond Office, IRS does not
routinely check to determine if all issuers of qualified private
activity bonds are complying with the statutory 2 percent limit on
using proceeds for issuance costs. He said that if the limit is
exceeded, it may be a potential compliance issue. During its
examinations of tax-exempt bonds, IRS routinely assesses whether
issuance costs exceed legal limits. The Director recognized the
importance of bond issuers adhering to the statutory issuance cost
limit; however, he also stated that because of resource constraints,
IRS places more emphasis on tax-exempt bond compliance examinations and
checks that have the most impact. He stated that in considering how
best to address potential compliance issues regarding issuance costs,
IRS would want to ensure that these inquiries are not automatically
construed as audits. Once IRS initiates an audit, it is precluded from
auditing the same return again in the same tax year even if more
substantial compliance issues arise. The Director indicated that IRS
has plans to conduct more special initiatives to monitor compliance
with tax-exempt bond rules than it has in the past, such as starting to
provide "soft notices" to certain bond issuers that could be used to
identify potential issues related to compliance. Soft notices alert
taxpayers to potential errors they made and encourage them to correct
such errors. In a number of cases, IRS has found many taxpayers do take
corrective actions. Because soft notices do not require taxpayers to
send IRS any information from their books and records, they are not
considered audits. Although it would need to be tested, the Director
thought it might be cost-effective to begin using soft notices, when
appropriate, to inform bond issuers that they reported issuance costs
paid from bond proceeds that exceed statutory limitations.
Unlike qualified private activity bonds, issuance costs for
governmental bonds are not subject to any limits; however, like
qualified private activity bonds, they vary based on the type of bond
and the size of the bond issue. For all governmental bonds issued from
2002 through 2005 where bond issuers reported issuance costs on the
Form 8038-G, median issuance costs paid from bond proceeds as a
percentage of bond proceeds ranged from 1.51 percent in 2005 to 1.67
percent in 2003. For bonds with reported issuance costs, from 34 to 39
percent indicated that issuance costs exceeded 2 percent of bond
proceeds, the statutory limit for most qualified private activity
bonds. Governmental bonds issued for housing generally had the highest
median issuance costs paid from bond proceeds as a percentage of bond
proceeds while bonds issued for education and health and hospital
purposes generally had the lowest median issuance costs paid from bond
proceeds as a percentage of bond proceeds. Table 9 shows the median
issuance costs paid from bond proceeds as a percentage of bond proceeds
for long-term governmental bonds issued from 2002 to 2005 by bond
purpose and size of bond.
Table 9: Median Issuance Costs as a Percentage of Bond Proceeds for
Long-term Governmental Bonds Issued from 2002 to 2005:
All types;
2002: 1.62;
2003: 1.67;
2004: 1.63;
2005: 1.51.
Purpose: Education;
2002: 1.36;
2003: 1.45;
2004: 1.36;
2005: 1.27.
Purpose: Health and hospital;
2002: 1.57;
2003: 1.41;
2004: 1.36;
2005: 1.19.
Purpose: Transportation;
2002: 1.61;
2003: 1.60;
2004: 1.47;
2005: 1.39.
Purpose: Public safety;
2002: 1.53;
2003: 1.46;
2004: 1.53;
2005: 1.44.
Purpose: Environment;
2002: 1.54;
2003: 1.62;
2004: 1.50;
2005: 1.50.
Purpose: Housing;
2002: 1.81;
2003: 1.93;
2004: 2.01;
2005: 1.98.
Purpose: Utilities;
2002: 1.82;
2003: 1.89;
2004: 1.76;
2005: 1.71.
Purpose: Other;
2002: 1.76;
2003: 1.75;
2004: 1.83;
2005: 1.72.
Size of issue: Under $1 million;
2002: 2.78;
2003: 2.59;
2004: 2.70;
2005: 2.77.
Size of issue: $1 million - under $10 million;
2002: 1.83;
2003: 1.86;
2004: 1.80;
2005: 1.73.
Size of issue: $10 million - under $50 million;
2002: 1.16;
2003: 1.12;
2004: 1.19;
2005: 1.15.
Size of issue: $50 million - under $100 million;
2002: 0.80;
2003: 0.83;
2004: 0.82;
2005: 0.82.
Size of issue: $100 million and over;
2002: 0.61;
2003: 0.62;
2004: 0.60;
2005: 0.58.
Source: GAO analysis of IRS data.
Note: The size of the issue is measured in 2007 dollars. The
percentages in the table are calculated from forms where issuance costs
paid from bond proceeds were reported. Forms where issuers reported
zero issuance costs paid from bond proceeds or left the line blank are
excluded from these median calculations.
[End of table]
Like qualified private activity bonds, smaller governmental bonds
generally had higher median issuance costs as a percentage of bond
proceeds. For example, for bonds under $1 million, the median issuance
cost paid from bond proceeds as a percentage of bond proceeds exceeded
2.5 percent in all years for 2002 through 2005. Median issuance costs
as a percentage of bond proceeds for governmental bonds issued for
amounts greater than $100 million were about 0.6 percent from 2002 to
2005.
Conclusions:
State and local governments have broad discretion in deciding which
activities and facilities to finance using tax-exempt bonds. In
particular, the broad discretion afforded to state and local
governments allows them to use tax-exempt governmental bonds to finance
facilities and activities that cannot be financed with private activity
bonds. Recently, the dollar amount of tax-exempt governmental bonds
reached peak levels as municipal governments issued bonds for a wide
variety of purposes ranging from traditionally public facilities, such
as schools, fire stations, and roads, to facilities that are
essentially private in nature, such as sports stadiums.
Congressional policymakers have recently shown interest in whether
certain facilities providing benefits that are essentially private in
nature, such as stadiums, should be financed with tax-exempt
governmental bonds. However, similar attention has not been given other
types of facilities, like hotels and golf courses that also provide
benefits that are essentially private in nature. As Congress continues
to hold discussions on whether sports stadiums are appropriate uses of
tax-exempt governmental bonds, it should also consider whether other
facilities that are privately used, such as hotels, should continue to
be financed with tax-exempt bonds. However, if Congress still views
these and other facilities that are essentially private in nature as
appropriate uses of tax-exempt governmental bonds, then legislative
changes would not be necessary.
Issuers of qualified private activity bonds must adhere to the limits
on using bond proceeds for issuance cost that are imposed by law. In
part, this helps to ensure that the federal subsidy afforded to issuers
of bonds for private uses is appropriately targeted to the purposes for
which the bonds were issued. This is equally important to ensure that
the bonds' tax-exempt status remains intact. In addition, it would be
more beneficial to IRS if its forms and instructions included specific
directions to bond issuers that did not use bond proceeds for issuance
costs to indicate this on the form. Although this may require that IRS
revise Form 8038, we believe that it would be beneficial for IRS to
know positively whether issuers used bond proceeds for issuance costs
and, if so, how much was used. This would better equip IRS to determine
if there are any compliance issues that need to be addressed. We
believe that if the Form 8038 is revised, the benefits to IRS would
likely outweigh the costs.
Matter for Congressional Consideration:
As Congress considers whether tax-exempt governmental bonds should be
used for professional sports stadiums that are generally privately
used, it should also consider whether other facilities, including
hotels and golf courses, that are privately used should continue to be
financed with tax-exempt governmental bonds.
Recommendations for Executive Action:
To better ensure that IRS can routinely and cost effectively determine
whether issuers of qualified private activity bonds are complying with
the statutory limits on using bond proceeds for issuance costs, we
recommend that the Commissioner of Internal Revenue take the following
two actions:
* Clarify IRS's forms and instructions for reporting issuance cost paid
from bond proceeds to require that bond issuers clearly designate on
the form instances when bond proceeds were not used to pay issuance
costs.
* Develop cost-effective methods to address apparent noncompliance with
the statutory limits on using bond proceeds for issuance costs in such
a manner that it would not preclude IRS from examining the bonds for
more substantive compliance issues in the future.
Agency Comments:
We provided a draft of this report to IRS and Treasury for comment. The
Acting Commissioner of Internal Revenue provided comments on a draft of
this report in a February 7, 2008, letter, which is reprinted in
appendix VI. IRS said that it agreed with our recommendations.
Regarding our recommendation that IRS clarify its forms and
instructions for reporting issuance cost paid from bond proceeds to
require that bond issuers clearly designate on the form instances where
bond proceeds were not used to pay issuance costs, IRS said that it
will clarify instructions for IRS Form 8038 to require that bond
issuers clearly indicate when no bond proceeds were used to pay
issuance costs. Concerning our recommendation that IRS develop cost-
effective methods to address apparent noncompliance with the statutory
limits, IRS said that it will develop a compliance project to address
apparent noncompliance with the issuance cost requirements for the
fiscal year 2009 tax-exempt bonds work plan that will likely
incorporate sending soft-contact letters similar to ones previously
used with success in other areas.
In a February 8, 2008, letter, Treasury's Assistant Secretary for Tax
Policy commented that the use of tax-exempt governmental bonds to
finance stadiums and other projects with significant private business
use is arguably a structural weakness in the targeting of the federal
tax expenditure for tax-exempt bonds under the existing legal
framework. Treasury pointed out that while the existing framework might
have a tax policy justification in giving municipal governments
flexibility to use governmental bonds for a range of public-private
partnerships, it may also be debatable in certain cases, such as for
certain stadium financings. Treasury noted its recent testimony that
outlined several options to address the possible structural weakness in
the targeting of tax-exempt bond subsidy relative to tax-exempt
governmental bonds for stadium financings. Treasury's comments are
reprinted in appendix VII.
As arranged with your offices, unless you publicly announce the
contents of this report earlier, we plan no further distribution of it
until 30 days after its date. At that time, we will send copies of this
report to the Commissioner of Internal Revenue and the Secretary of the
Treasury and other interested parties. We will also provide copies to
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If you or your staff members have any questions about this report,
please contact me at (202) 512-9110 or brostekm@gao.gov. Contact points
for our Offices of Congressional Relations and Public Affairs may be
found on the last page of this report. GAO staff who made contributions
to this report are listed in appendix VIII.
Signed by:
Michael Brostek:
Director, Tax Issues Strategic Issues:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
The objectives of this report were to (1) describe recent trends in the
dollar volume of tax-exempt bonds; (2) provide information on the types
of facilities and activities that are financed with tax-exempt bonds,
in particular, information on hotels and municipal golf courses that
were recently financed with tax-exempt bonds; and (3) provide
information on borrowing costs that bond issuers pay when issuing bonds
by summarizing relevant research on whether bond interest costs vary by
the method of sale, considering characteristics of the bond and bond
issuer and provide information on how bond issuance costs vary between
governmental and private activity bonds, including the extent to which
private activity bond issuers exceed the statutory limit for issuance
costs as a percentage of bond proceeds.
To provide information on trends in the volume of tax-exempt bonds, we
relied primarily on data from the Internal Revenue Service's (IRS)
Statistics of Income Division (SOI), which collects statistical data
from information returns that tax-exempt bond issuers are required to
file with IRS. We used SOI data from 1991 through 2005, the most
recently available data, to provide information on the overall volume
of tax-exempt bonds issued, the volume of governmental and private
activity bonds issued, and the volume of new money versus refunding
bonds issued. We also relied on the 20-Bond Index in the 2007 Bond
Buyer Yearbook, which presents average interest rates on a set of 20
investment grade general obligation bonds maturing in 20 years, to
compare interest rate changes from 1992 through 2005 with the volume of
new money and refunding tax-exempt bond issues. We used data from the
Technical Appendix of the President's Budget for fiscal years 2002,
2004, 2006, and 2008 and data from the Joint Committee on Taxation's
2007 Estimates of Federal Tax Expenditures to provide estimates of the
amount of forgone revenue resulting from the exclusion of interest
earned on tax-exempt bonds from federal income taxes.
To describe the types of activities and facilities that are being
financed with tax-exempt bonds, we relied on data in the 2007 Bond
Buyer Yearbook, IRS's SOI data, and a limited random sample of official
statements. We used Bond Buyer Yearbook information because it provided
us with more information about the purposes of tax-exempt bonds than
other private data sources we identified. Data in the 2007 Bond Buyer
Yearbook provide summary information on the uses of municipal bonds in
10 main categories and 48 subcategories. Information in the Bond Buyer
Yearbook is obtained from Thomson Financial's municipal bond database,
one of the most comprehensive data sources on tax-exempt bonds. One
limitation of the Bond Buyer Yearbook is that it does not provide
separate breakouts of the uses of governmental and private activity
bonds and includes taxable bonds. Taxable municipal bonds generally
account for less than 10 percent of all municipal bonds.
We used SOI data to provide information on the uses of governmental and
private activity bonds. IRS's SOI collects data on the purposes of
governmental and qualified private activity bonds as reported on Form
8038-G and Form 8038, respectively. The information is summarized into
broad categories for governmental bonds and by allowable uses for
qualified private activity bonds. IRS generates summary tables on tax-
exempt bond uses that are posted on IRS's Web site and published in
regularly issued bulletins. We used IRS's SOI tax-exempt bond data for
2002 through 2005 to analyze the other category for governmental bond
purposes and the nonhospital 501(c)(3) category for qualified private
activity bond purposes.
In some cases, information from the Bond Buyer Yearbook and information
from the SOI database differ for similar types of bonds and for
statistics about similar bond characteristics. Several possible reasons
exist for the difference between summary information from SOI and the
Bond Buyer Yearbook. For example, SOI relies on bond issuers to timely
and accurately report bond information while Thomson Financial relies
on automated reporting systems from the financial marketplace to
develop reports in the Bond Buyer Yearbook. Even though the amounts
differ in some instances for SOI and Bond Buyer data, our testing of
these data allowed us to conclude that both sources were sufficiently
reliable for providing information on tax-exempt bonds used in this
report.
We reviewed a limited random sample of official statements to provide
more detailed information about the specific uses of tax-exempt
governmental bonds than can typically be found in other data sources,
such as the Bond Buyer Yearbook and the SOI data. The sample was not
designed to provide projectable data on the uses of tax-exempt bonds.
We drew the sample using the Municipal Securities Rulemaking Board's
(MSRB) database of official statements that it received in calendar
year 2006. MSRB is a congressionally chartered organization that
regulates securities firms and banks involved in underwriting, trading,
and selling municipal securities, and based on its rules, bond issuers
are required to send a copy of their final official statements to it.
We reviewed the randomly ordered official statements until we
identified five official statements that we determined would likely be
included in each of the eight categories in the SOI data.
For providing information on hotels that were financed with tax-exempt
bonds, we could not find a comprehensive, reliable source with
information on the numbers of hotels financed with tax-exempt bonds.
Thus, we provide some limited data from the best available sources we
could find for hotels financed with tax-exempt bonds from 2002 through
2006. We used these recent years because information on financing for
these hotels would more likely be available than information for hotels
financed in earlier years. To identify the hotels, we used information
from a previous GAO report;[Footnote 33] HVS International, a global
consulting services firm that focuses on hotel and hospitality
services; and Bond Buyer daily publications that provide additional
information on municipal bonds. From these sources we identified a
number of hotels that may have been financed with tax-exempt bonds.
However, we were only able to confirm that the 18 hotels identified in
our report were financed, at least in part, with tax-exempt bonds by
reviewing official statements and government financial reports and
contacting local officials. The list of hotels we present likely is not
a comprehensive list of all hotels financed with tax-exempt bonds.
For providing information on municipal golf courses that were financed
with tax-exempt bonds, we could not find a comprehensive, reliable
source with information on the number of municipal golf courses
financed with tax-exempt bonds. Thus, similar to our review of hotels,
we provide limited data from the best available sources we could find.
We used the National Golf Foundation's database to identify municipal
golf courses that opened in 2005. We identified nine municipal golf
courses that opened in 2005. However, the National Golf Foundation's
database did not have information on whether the golf courses were
financed with tax-exempt bonds. To confirm whether these nine municipal
golf courses were financed with tax-exempt bonds, we contacted city,
county, and golf course officials. From these contacts, we determined
that six of the nine municipal golf courses were financed with tax-
exempt bonds, and we obtained the official statements for those
municipal golf courses.
To provide information on borrowing costs, we conducted a literature
review of previous studies that reviewed whether bond issuance costs
vary by method of sale, including characteristics of the bond and bond
issuers, and we analyzed IRS data on issuance costs. We reviewed
studies published in peer-reviewed academic journals from 1996 through
2007. Because the studies we reviewed had several limitations,
including that they were limited to certain states for certain time
periods or focused only on certain market sectors, we initially
attempted to conduct original research on this topic by obtaining a
broad set of data on tax-exempt bonds and developing similar
econometric analysis to the studies we reviewed that would have covered
a wider range of bonds over a longer time period. However, we
determined that the available data were not sufficiently reliable for
our purposes. As a result, we confined our review of bond issuance
costs to a summary of previous studies that attempt to address the same
issue, but not on as wide of a scale as we had initially intended. We
analyzed IRS's SOI data on tax-exempt bonds from 2002 to 2005 to
identify how issuance costs vary between governmental and private
activity bonds. We reviewed issuance costs as a percentage of total
bond proceeds for the various categories of governmental and qualified
private activity bonds and by bond size. We also used IRS data to
identify the extent to which issuance costs for qualified private
activity bonds exceed the statutorily required 2 percent limit and the
extent to which bond issuers do not report issuance costs on the IRS
Forms 8038 and 8038-G.
We interviewed officials in IRS's Tax-Exempt Bond Office in its
Government Entities and Tax-Exempt Division and Treasury's Office of
Tax Policy and other experts in taxation and government finance, such
as representatives of the Government Finance Officers' Association, the
Securities Industry and Financial Markets Association, and the
Congressional Research Service, to gain an understanding about the
volume and uses of tax-exempt bonds. We determined that the data we
evaluate in this report were sufficiently reliable for our purposes. We
performed our work from December 2006 through January 2008 in
accordance with generally accepted government auditing standards.
[End of section]
Appendix II: Sources of Information on the Facilities and Activities
Financed Using Tax-Exempt Bonds:
Information on the types of facilities and activities that are financed
with tax-exempt bonds is available from several sources, including the
official statements prepared by underwriters to market the bonds, IRS,
and private vendors, such as Thomson Financial.[Footnote 34] Specific
information on what tax-exempt bonds are used for varies by source.
Overall, the official statement generally contains the most detailed
descriptive information. However, because there are no standard
guidelines on the format and content of official statements, the level
of detailed information they contain on the facilities and activities
financed with tax-exempt bonds varies. For example, an official
statement for a bond issued in 2006 stated that the bond was to be used
to construct and improve the water facility for a municipality. Another
official statement for a bond issued the same year showed that the
bonds were to be used for various capital improvements. While in the
first instance, the official statement more clearly discloses what the
bond is to be used for, it is not fully apparent from the other example
what specific capital improvements were financed by the bond.[Footnote
35]
The information IRS collects on tax-exempt bonds is transcribed from
information returns bond issuers are required to send IRS. By law, bond
issuers are required to file IRS Form 8038-G, Information Return for
Tax-Exempt Government Obligations for Governmental Bonds for bonds with
an issue price of $100,000 or greater, or IRS Form 8038, Information
Return for Tax-Exempt Private Activity Bonds. In filling out the form,
a bond issuer checks boxes that best describe the types of facilities
and activities to be financed with the bonds. For governmental bonds,
the form has eight broad categories, including education,
transportation, public safety, and other. If the other category is
checked, the bond issuer is also asked to write in information that
describes the intended use of bond proceeds. While the information that
IRS collects from the form is useful in presenting summary information
on the facilities and activities financed with governmental bonds, it
only presents a very broad picture of the facilities for which the
bonds are used. For example, if the bond issuer checked education, it
is only apparent that the bonds were intended for educational
facilities and activities. However, the specific nature of the
educational facilities and activities is unknown based on the type of
data IRS collects. For instance, it would not be apparent whether the
bonds were used to finance new educational facilities, such as public
and charter schools; fund teachers' pension plans; construct a college
athletic field; or pay for computer equipment used in a school.
Likewise, issuers of private activity bonds are required to send IRS a
similar form wherein they check boxes that broadly describe the
facilities and activities financed with the bonds. IRS publishes
descriptive statistics from these forms.
Another source of information on the facilities and activities financed
by tax-exempt bonds that we used was the Bond Buyer Yearbook, a
publication by Thomson Financial that summarizes information on
municipal bonds on a yearly basis. Information in the Bond Buyer
Yearbook is obtained from several sources and provides one of the most
comprehensive sources of information describing the facilities and
activities financed by municipal bonds.[Footnote 36] The Bond Buyer
Yearbook categorizes the facilities and activities financed by
municipal bonds based on 10 broad categories and 48 subcategories. Even
though the Bond Buyer Yearbook categorizes municipal bonds into many
categories, the information only presents a general picture of the
range of facilities and activities for which the bonds are used. For
example, the Bond Buyer Yearbook development category has 3
subcategories--industrial, economic, and office buildings. From this
summarized information, it is not apparent whether facilities such as
hotels financed with tax-exempt governmental bonds are included as
economic development.
It is also important to note that Bond Buyer Yearbook information on
the uses of bonds does not distinguish between tax-exempt governmental,
qualified private activity, and taxable municipal bonds. However,
according to Bond Buyer Yearbook information, generally less than 10
percent of all municipal bonds issued annually are taxable. Despite
that, the Bond Buyer Yearbook is a useful source for summarized
information on the types of facilities and activities that are financed
using municipal bonds, including tax-exempt bonds.
[End of section]
Appendix III: Summary of Thomson Financial 2007 Bond Buyer Yearbook
Data, Use of Proceeds, 2002-2006 Combined:
Table 10:
Dollars in thousands (constant 2007 dollars).
[See PDF for image]
Source: GAO analysis of Thomson Financial data in the 2007 Bond Buyer
Yearbook.
[End of table]
[End of section]
Appendix IV: Amount and Number of New Money, Long-term Governmental
Bonds Issued by IRS SOI Purpose Categories, 2001-2005 Combined:
Table 11:
Dollars in millions (constant 2007 dollars).
Education;
Total amount: $266,513;
Percentage of total amount: 32.7;
Total issues: 23,202;
Percentage of total issues: 30.4;
Average size: $11.5.
Other;
Total amount: 263,796;
Percentage of total amount: 32.3;
Total issues: 22,342;
Percentage of total issues: 29.3;
Average size: 11.8.
Transportation;
Total amount: 100,671;
Percentage of total amount: 12.3;
Total issues: 4,887;
Percentage of total issues: 6.4;
Average size: 20.6.
Utilities;
Total amount: 91,235;
Percentage of total amount: 11.2;
Total issues: 7,742;
Percentage of total issues: 10.1;
Average size: 11.8.
Environment;
Total amount: 47,736;
Percentage of total amount: 5.8;
Total issues: 5,470;
Percentage of total issues: 7.2;
Average size: 8.7.
Health and hospital;
Total amount: 18,363;
Percentage of total amount: 2.3;
Total issues: 1,832;
Percentage of total issues: 2.4;
Average size: 10.0.
Public safety;
Total amount: 21,200;
Percentage of total amount: 2.6;
Total issues: 10,203;
Percentage of total issues: 13.4;
Average size: 2.1.
Housing;
Total amount: 6,583;
Percentage of total amount: 0.8;
Total issues: 643;
Percentage of total issues: 0.8;
Average size: 10.2.
Total;
Total amount: $816,099;
Percentage of total amount: 100.0;
Total issues: 76,321;
Percentage of total issues: 100.0;
Average size: $10.7.
Source: GAO analysis of IRS's Statistics of Income Division data.
[End of table]
[End of section]
Appendix V: List of Studies Reviewed on Interest Costs in Competitive
and Negotiated Sales:
Gershberg, Alec Ian, Michael Grossman, and Fred Goldman. "Competition
and the Cost of Capital Revisited: Special Authorities and Underwriters
in the Market for Tax-Exempt Hospital Bonds." National Tax Journal,
vol. 54, no. 2 (2001): 255-280.
Kriz, Kenneth A. "Comparative Costs of Negotiated versus Competitive
Bond Sales: New Evidence From State General Obligation Bonds." The
Quarterly Review of Economics and Finance, vol. 43 (2003): 191-211.
Leonard, Paul A. "An Empirical Analysis of Competitive Bid and
Negotiated Offerings of Municipal Bonds." Municipal Finance Journal,
vol. 17, no. 1 (1996): 37-66.
Peng, Jun and Peter F. Brucato, Jr. "Another Look at the Effect of
Method of Sale on the Interest Cost in the Municipal Bond Market--A
Certification Model." Public Budgeting and Finance, vol. 23, no. 1
(2003): 73-95.
Robbins, Mark D. and Bill Simonsen. "Competition and Selection in
Municipal Bond Sales: Evidence From Missouri." Public Budgeting and
Finance, vol. 27, no. 2 (2007): 88-103.
Simonsen, Bill, Mark D. Robbins, and Lee Helgerson. "The Influence of
Jurisdiction Size and Sale Type on Municipal Bond Interest Rates: An
Empirical Analysis." Public Administration Review, vol. 61, no. 6
(2001): 709-717.
Simonsen, William and Mark. D. Robbins. "Does It Make Any Difference
Anymore? Competitive versus Negotiated Municipal Bond Issuance." Public
Administration Review, vol. 56, no. 1 (1996): 57-64.
[End of section]
Appendix VI: Comments from the Internal Revenue Service:
Department Of The Treasury:
Internal Revenue Service:
Washington, D.C. 20224:
February 7, 2008:
Mr. Michael Brostek:
Director, Tax Issues:
Strategic Issues:
United States Government Accountability Office:
Washington, D.C. 20548:
Dear Mr. Brostek:
We appreciate the opportunity to review your draft report concerning
tax-exempt bonds and the issue of compliance with limitations on
issuance costs. The report fairly represents the growth, character and
size of the tax-exempt bond market, and its impact on federal revenues.
Although the choice made by the issuer of tax-exempt bonds between a
competitive or a negotiated sale method does not present issues under
the federal tax laws, it is clear that the choice of sales method can
significantly affect the cost of issuing the bonds.
The Internal Revenue Service (IRS) is committed to ensuring compliance
with the federal tax law applicable to tax-exempt bonds. Our Tax Exempt
Bond function, within the Tax Exempt and Government Entities division,
operates enforcement, educational, and voluntary compliance programs to
ensure compliance with the applicable law and to assist the issuers of
tax-exempt bonds in understanding their tax responsibilities.
These programs include an audit planning process that takes into
account non- compliance with the federal tax law requirements related
to issuance costs. They also include a program involving both general
examination activity and compliance checks. For example, we recently
sent charities a compliance questionnaire inquiring whether they were
properly maintaining documentation reflecting the allocation of bond-
financed proceeds to bond issuance costs. We also have developed and
distributed two compliance guides that educate issuers and borrowers
regarding issuance cost requirements (Publication 4077, Tax-Exempt
Bonds for 501(c)(3) Charitable Organizations, and Publication 4078, Tax-
Exempt Private Activity Bonds Compliance Guide).
Thank you for your interest in this area. If you have questions
concerning this response, please contact Steven T. Miller,
Commissioner, Tax Exempt and Government Entities, at (202) 283-2500.
Sincerely,
Signed by:
Linda E. Stiff:
Acting Commissioner of Internal Revenue:
Enclosure:
Recommendation One:
To better ensure that IRS can routinely and cost effectively determine
whether issuers of qualified private activity bonds are complying with
the statutory limits on using bond proceeds for issuance costs, we
recommend that the Commissioner of Internal Revenue should clarify its
forms and instructions for reporting issuance cost paid from bond
proceeds to require that bond issuers clearly designate on the form
instances when bond proceeds were not used to pay issuance costs.
Response:
The IRS agrees with this recommendation. We will clarify the
instructions for IRS Form 8038, Information Return for Tax Exempt
Private Activity Bond issues, to require that bond issuers clearly
indicate when no bond proceeds were used to pay issuance costs.
Recommendation Two:
To better ensure that IRS can routinely and cost effectively determine
whether issuers of qualified private activity bonds are complying with
the statutory limits on using bond proceeds for issuance costs, we
recommend that the Commissioner of Internal Revenue develop cost-
effective methods to address apparent noncompliance with the statutory
limits on using bond proceeds for issuance costs in such a manner that
would not preclude IRS from examining the bonds for more substantive
compliance issues in the future.
Response:
The IRS agrees with this recommendation. For the FY 2009 Tax Exempt
Bonds Work Plan, we will develop a compliance project that will address
apparent non-compliance with the issuance cost requirements but will
not preclude us from examining the bonds for other issues at a later
date. This compliance project will most likely incorporate "soft-
contact" letters of the sort we have used successfully in other areas
in the past.
[End of section]
Appendix VII: Comments from the Department of the Treasury:
Department Of The Treasury:
Washington, D.C.:
Assistant Secretary:
February 8, 2008:
Mr. Michael Brostek:
Director, Tax Issues, Strategic Issues Team:
United States Government Accountability Office:
Washington, DC 20548
Dear Mr. Brostek:
Thank you for providing the Treasury Department with an opportunity to
review and comment on your draft report, entitled "Tax Policy: Tax-
exempt Status of Certain Bonds Merits Reconsideration and IRS Should
Address Apparent Noncompliance with Issuance Cost Limitations (GAO-08-
364)." John Cross, Associate Tax Legislative Counsel, previously
provided technical comments to your staff on the draft report.
I want to take the opportunity in this letter to underscore one main
point referenced in your report that I made in recent testimony before
the House Committee on Oversight and Government Reform's Domestic
Policy Subcommittee on October 10, 2007. A copy of my testimony is
attached. In particular, from a tax policy perspective, the ability to
use tax-exempt governmental bonds to finance stadiums and other
projects with significant private business use when the bonds are
subsidized with State or local governmental payments, such as generally
applicable taxes, arguably represents a structural weakness in the
targeting of the Federal tax expenditure for tax-exempt bonds under the
existing legal framework. That possible structural weakness exists
because current law generally allows characterization of bonds as tax-
exempt governmental bonds unless more than 10 percent of the bond
proceeds are both used for private business use and are payable from
private payments. Thus, governmental bonds, which are not subject to
the state volume cap and other limitations of qualified private
activity bonds, may finance a project with significant private business
use so long as private payments are limited.
The tax policy justification for the existing framework is that it
gives State and local governments appropriate flexibility to use
governmental bonds to finance a range of projects in public-private
partnerships with significant private business use when the projects
are sufficiently important to warrant subsidizing them with State and
local governmental funds. Here, political constraints against
commitment of governmental funds ordinarily serve as a sufficient check
against excess financing of such projects. This justification may be
debatable in certain cases, such as in the case of certain stadium
financings. My above-noted recent testimony outlined several options
that could be considered to address the possible structural weakness in
the targeting of the tax-exempt bond subsidy relative to tax-exempt
governmental bonds for stadium financings.
At this time, the Administration does not take a position on any
specific policy option with respect to possible legislative changes to
the tax-exempt bond provisions relative to stadium financings or other
governmental bond financings involving significant private business
use. This topic raises difficult questions that require balancing the
interests of State and local governments in having flexibility to
finance projects they deem sufficiently important to subsidize with
governmental funds and the Federal interest in ensuring effective
targeting of the Federal tax expenditure for tax-exempt bonds. The
Administration recognizes that review of this important Federal tax
expenditure may be appropriate in considering ways more generally to
simplify this area and to ensure effective targeting of this subsidy
for public infrastructure.
Thank you again for the opportunity to comment on your draft report.
Sincerely,
Signed by:
Eric Solomon:
Assistant Secretary (Tax Policy):
Attachment:
U.S. Treasury Department Office Of Public Affairs:
Embargoed Until 2 P.M. EDT October 10, 2007:
Contact Andrew DeSouza (202) 622-2960:
Testimony Of Treasury Assistant Secretary For Tax Policy Eric Solomon
Before The House Oversight Subcommittee On Domestic Policy
On Tax Exempt Bond Financing:
Washington, DC” Chairman Kucinich, Ranking Member Issa, and
distinguished Members of the Subcommittee:
I appreciate the opportunity to appear before you today to discuss
certain Federal tax issues regarding the use of tax-exempt bond
financing The Administration recognizes that tax-exempt bond financing
plays an important role as a source of lower-cost financing for State
and local governments As a nation, we are focusing on the critical need
to support capital investment in public infrastructure The Federal
government provides an important Federal subsidy for tax-exempt bond
financing through the Federal income tax exemption for interest paid on
State or local bonds under Section 103 of the Internal Revenue Code
(the "Code"), which enables State and local governments to finance
public infrastructure projects and other public-purpose activities at
lower costs
The cost to the Federal government of tax-exempt bonds is significant
and growing. Unlike direct appropriations, however, the cost of this
Federal subsidy receives less attention because it is not tracked
annually through the appropriations process. In addition, it also is
important to recognize that the, Federal subsidy for tax-exempt bonds
is less efficient than that for direct appropriations because of the
inefficiency of pricing in the tax-exempt bond market. In this regard,
since some bond purchasers have higher marginal, tax rates than those
of the bond purchasers needed to clear the market, tax-exempt bonds
cost the Federal government more in foregone revenue than they deliver
to State and local governments in reduced interest expenses The steady
growth in the volume of tax-exempt bonds reflects the importance of
this incentive in addressing public infrastructure and other needs. At
the same time, it is appropriate to review the tax-exempt bond program
to ensure that it is properly targeted and that the Federal subsidy is
justified in light of the lost Federal revenue and other costs imposed
My testimony covers four main issues First, my testimony provides an
overview of the legal framework for tax-exempt bonds. Second, it
discusses the use of tax-exempt bonds to finance public infrastructure
projects and stadium projects under the existing legal framework.
Third, my testimony comments on certain tax policy and regulatory
authority considerations Finally, it provides certain statistical data
on tax-exempt bonds for background.
Overview of Legal Framework for Tax-Exempt Bonds:
A. Introduction:
In general, there are two basic types of tax-exempt bonds: Governmental
Bonds and Private Activity Bonds Bonds generally are classified as
Governmental Bonds if the proceeds are used for State or local
governmental use or the bonds are repaid from State or local
governmental sources of funds Bonds generally are classified as Private
Activity Bonds if they meet the definition of a Private Activity Bond
under the Code, based on specified levels of private business
involvement In general, the interest on Private Activity Bonds is
taxable unless the bonds meet qualification requirements for financing
certain projects and programs specifically identified in the Code
B. Governmental Bonds:
State and local governments issue Governmental Bonds to finance a wide
range of public infrastructure projects The Code does not provide a
specific definition of "Governmental Bonds " Instead, bonds are
generally treated as Governmental Bonds if they avoid classification as
Private Activity Bonds, as defined in the Code, by limiting private
business use or private business sources of payment or security, and
also by limiting private loans_ Here, it is important to appreciate
that bonds can qualify as Governmental Bonds if they are either used
predominantly for State or local governmental use or payable
predominantly from State or local governmental sources of funds, such
as generally applicable taxes. Stated differently, under the current
legal framework, Governmental Bonds can be used to finance a project
that has significant private business use or that are payable from
significant private business sources of payment, but not both.
In order for the interest on Governmental Bonds to be excluded from the
bond holder's gross income for Federal tax purposes, a number of
general eligibility requirements must be met Requirements generally
applicable to all tax-exempt bonds include arbitrage restrictions, bond
registration and information reporting requirements, a general
prohibition on Federal guarantees, advance refunding limitations,
restrictions on unduly long spending periods, and pooled financing bond
limitations.
C. Private Activity Bonds:
1. In General:
Under section 141 of the Code, bonds are classified as Private Activity
Bonds if more than 10 percent of the bond proceeds are both:
(I) used for private business use (the "private business use
limitation"); and:
(2) payable or secured from payments derived from property used for
private business use (the "private payments limitation").
Bonds also are treated as Private Activity Bonds if more than the
lesser of $5 million or 5 percent of the bond proceeds are used to
finance private loans, including business and consumer loans. The
permitted private business thresholds are reduced from 10 percent to 5
percent for certain private business use that is "unrelated" to
governmental use or that is "disproportionate" to governmental use
financed in a bond issue. These tests are intended to identify
arrangements that have the potential to transfer the benefits of tax-
exempt financing to nongovernmental persons.
2. Projects and Programs Eligible for Tax-Exempt Private Activity Bond
Financing:
Private Activity Bonds may be issued on a tax-exempt basis only if they
meet the requirements for qualified Private Activity Bonds, including
targeting requirements that limit such financing to specifically
defined facilities and programs. Under present law, qualified Private
Activity Bonds may be used to finance eligible projects and activities,
including the following: (1) airports, (2) docks and wharves, (3) mass
commuting facilities, (4) facilities for the furnishing of water, (5)
sewage facilities, (6) solid waste disposal facilities, (7) qualified
low-income residential rental multifamily housing projects, (8)
facilities for the local furnishing of electric energy or gas, (9)
local district heating or cooling facilities, (10) qualified hazardous
waste facilities, (11) high-speed intercity rail facilities, (12)
environmental enhancements of hydroelectric generating facilities, (13)
qualified public educational facilities, (14) qualified green buildings
and sustainable design projects, (15) qualified highway or surface
freight transfer facilities, (16) qualified mortgage bonds or qualified
veterans mortgage bonds for certain single-family housing facilities,
(17) qualified small issue bonds for certain manufacturing facilities,
(18) qualified student loan bonds, (19) qualified redevelopment bonds,
(20) qualified 501(c)(3) bonds for the exempt charitable and
educational activities of Section 501(c)(3) nonprofit organizations,
(21) certain projects in the New York Liberty Zone, and (22) certain
projects in the Gulf Opportunity Zone,
Qualified Private Activity Bonds are subject to the same general rules
applicable to Governmental Bonds, including the arbitrage investment
limitations, registration and information reporting requirements, the
Federal guarantee prohibition, restrictions on unduly long spending
periods, and pooled financing bond limitations. In addition, most
qualified Private Activity Bonds are also subject to a number of
additional rules and limitations. One notable additional rule limits
the annual amount of these bonds that can be issued in each state (the
"bond volume cap" limitation) under section 146 of the Code Another
notable additional rule prohibits advance refundings for most Private
Activity Bonds under section 149(d)(2) (other than for qualified
501(0(3) bonds). Further, unlike the tax exemption for interest on
Governmental Bonds, the tax exemption for interest on most qualified
Private Activity Bonds is generally heated as a preference item under
the alternative minimum tax ("AMT"), meaning that the benefit of an
exclusion from income for interest paid on these bonds can be taken
away by the AMT
The current legal framework for Private Activity Bonds was enacted as
part of the Tax Reform Act of 1986. The basic purpose of the Private
Activity Bond limitations was to limit the ability of State and local
governments to act as conduit issuers in financing projects for the use
and benefit of private businesses and other private borrowers except in
prescribed, circumstances. Prior to the Tax Reform Act of 1986, the
predecessor legal framework had more liberal rules regarding the use of
tax-exempt bonds for the benefit of private businesses (then called
"industrial development bonds"), including a more liberal 25-percent
limitation on permitted private business use and private payments (as
compared to the present 10-percent private business and private payment
limitations), and it did not include bond volume cap limitations on
private activity bonds.
Prior to the Tax Reform Act of 1986, stadiums were on the list of
eligible facilities that could be financed with tax-exempt industrial
development bonds. Stadiums were removed from the list of facilities
eligible for tax-exempt Private Activity Bond financing in 1986, but
stadiums remain eligible for Governmental Bond financing
notwithstanding the substantial private business use of these
facilities if they meet the requirements for Governmental Bonds. Under
current law, these requirements can generally be met when State and
local governments subsidize the projects with governmental revenues or
generally applicable taxes.
3 The Private Business Use Limitation:
In general, private business use of mole than 10 pet cent of the
proceeds of a bond issue violates the private business use limitation
Private business use generally arises when a private business has legal
rights to use bond-financed property Thus, private business use arises
from ownership, leasing, certain management arrangements, certain
research arrangements, certain utility output contract arrangements (e
g, certain electricity purchase contracts under which private utilities
receive benefits and burdens of ownership of governmental electric
generation facilities), and certain other arrangements that convey
special legal entitlements to bond-financed property.
Various exceptions and safe harbors apply with respect to the private
business use limitation, which allow limited private business use of
property financed by Private Activity Bonds in prescribed
circumstances. Exceptions to the private business use limitation
include exceptions for use in the capacity as the general public, such
as use by private businesses of public roads ("general public use"),
certain very short-term use arrangements, certain de minimis incidental
uses, certain uses as agents of State and local governments, and
certain uses incidental to financing arrangements (e g , certain
bondholder trustee arrangements). In addition, safe harbors against
private business use apply to certain private management and research
arrangements Thus, for management contracts, in Rev. Proc. 97-13, 1997-
1 C.B 632, the IRS provided safe harbors that allow private businesses
to enter into certain qualified management contracts with prescribed
terms and compensation arrangements without giving rise to private
business use to accommodate public-private partnerships for private
management of public facilities. For research contracts, in Rev Proc.
2007-47, 2007-29 I R B 108 (July 16, 2007), the IRS provided updated
safe harbors that allow certain research contract arrangements with
private businesses at tax-exempt bond financed research facilities
without giving rise to private business use (e g , certain Federally
sponsored research)
4 The Private Payments Limitation:
In general, private payments aggregating more than 10 percent of the
debt service on a bond issue (on a present value basis) violates the
private payments limitation. The private payments limitation considers
direct and indirect payments with respect to property used by private
businesses that represent sources of payment or security for the debt
service on a bond issue- For example, if a private business pays rent
for its use of the bond-financed property, the rent payments give rise
to private payments. Various limited exceptions apply for purposes of
the private payments limitation.
5 The Generally Applicable Taxes Exception to the Private Payments
Limitation:
A notable exception to the private payments limitation applies to
payments from generally applicable taxes In the legislative history to
the Tax Reform Act of 1986, Congress indicated its intent to exclude
revenues from generally applicable taxes from treatment as private
payments for purposes of the private payments limitation. The
Conference Report to the Tax Reform Act of 1986 included the following
statement:
Revenues flue; generally applicable taxes are not treated as payments
for purposes of the security interest lest; however, special charges
imposed on persons satisfying the use test (but not on members of the
public generally) are so treated if the charges are in substance fees
paid for the use of bond proceeds.[Footnote 37]
Consistent with this legislative history, Treasury Regulations define a
generally applicable tax as an enforced contribution imposed under the
taxing power that is imposed and collected for the purpose of raising
revenue to be used for a governmental purpose A generally applicable
tax must have a uniform tax rate that is applied equally to everyone in
the same class subject to the tax and that has a generally applicable
manner of determination and collection By contrast, a payment for a
special privilege granted or service rendered is not considered a
generally applicable tax Special assessments imposed on property owners
who benefit from financed improvements are also not considered
generally applicable taxes For example, a tax that is limited to the
property or persons benefiting from an improvement is not considered a
generally applicable tax Although taxes must be determined and
collected in a generally applicable manner, the Treasury Regulations
permit certain agreements to be made with respect to those taxes An
agreement to reduce or limit the amount of taxes collected to further a
bona fide governmental purpose is such a permissible agreement Thus, an
agreement to abate taxes to encourage a property owner to rehabilitate
property in a distressed area is a permissible agreement
In addition, the Treasury Regulations treat certain "payments in lieu
of taxes" and other tax equivalency payments ("PILOTs") as generally
applicable taxes.[Footnote 38] Under the current Treasury Regulations,
a PILOT is treated as a generally applicable tax if the payment is
"commensurate with and not greater than the amounts imposed by a
statute for a tax of general application." For instance, lithe payment
is in lieu of property tax on the bond-financed facility, it may not be
greater in any given year than what the actual property tax would be on
the property. In addition, to avoid being a private payment, a PILOT
must be designated for a public purpose and not be a special charge.
Under this rule, a PILOT paid for the use of bond-financed property is
treated as a special charge.
In 2006, the Treasury Department and the Internal Revenue Service (IRS)
published Proposed Regulations to modify the standards for the
treatment of PILOTs to ensure a close relationship between eligible
PILOT payments and generally applicable taxes Under the Proposed
Regulations, a payment is commensurate with general taxes only if the
amount of the payment represents a fixed percentage of, or a fixed
adjustment to, the amount of generally applicable taxes that otherwise
would apply to the property in each year if the property were subject
to tax. For example, a payment is commensurate with generally
applicable taxes if it is equal to the amount of generally applicable
taxes in each year, less a fixed dollar amount or a fixed adjustment
determined by reference to characteristics of the property, such as
size or employment. The Proposed Regulations permit the level of fixed
percentage or adjustment to change one time following completion of
development of the property. The Proposed Regulations also provide that
eligible PILOT payments must be based on the current assessed value of
the property for property taxes for each year in which the PILOTs are
paid, and the assessed value must be determined in the same manner and
with the same frequency as property subject to generally _applicable
taxes. A payment is not commensurate if it is based in any way on debt
service with respect to an issue or is otherwise set at a fixed dollar
amount that cannot vary with the assessed value of the property. The
Treasury Department and the IRS are in the process of reviewing the
public comments on the Proposed Regulations regarding the treatment of
PILOTs.
Governmental Bonds for Public Infrastructure Projects and Private
Stadiums Under the Existing Legal Framework:
A. Public Infrastructure Projects:
For public infrastructure projects, qualification for Governmental Bond
financing focuses on limiting private business use to not more than 10-
percent private business use under the first prong of the Private
Activity Bond definition In general, Governmental Bonds are an
important tool that State and local governments use to finance public
infrastructure projects to carry out traditional governmental
functions, such as providing public roads, bridges, courthouses, and
schools Typically, State and local governments finance public
infrastructure projects with Governmental Bonds based on predominant
State or local governmental use of the projects and limited private
business use within the permitted 10- percent private business use
limitation for Governmental Bonds Often, State and local governments
finance public infrastructure projects with Governmental Bonds based in
part on reliance on the general public use exception to private
business use Thus, for example, public roads may be financed with
Governmental Bonds even if private businesses use them in the same way
as individual members of the general public.
The tax policy justification for a Federal subsidy for tax-exempt bonds
is strongest in circumstances where State or local governments use
Governmental Bonds to finance public infrastructure projects and other
traditional governmental functions to carry out clear public purposes.
B. Private Stadiums:
For stadium projects that are acknowledged to exceed the 10-percent
private business use limitation, qualification for Governmental Bond
financing depends on limiting private payments to comply with the 10-
percent private payments under the second prong of the Private Activity
Bond definition. Here, it is important to recognize that, under the
existing legal framework, bonds are classified as Private Activity
Bonds only if they exceed both the 10-percent private business use
limitation and the 10-percent private payments limitation Thus, a State
or local government may issue tax-exempt Governmental Bonds to finance
a project that is 100-percent used for private business use, such as a
stadium that a private professional sports team uses 100-percent for
private business use, provided that the issuer does not receive private
payments from the team or elsewhere that in the aggregate exceed the 10-
percent private payments limitation. Alternatively, a State or local
government may issue tax-exempt Governmental Bonds to finance a stadium
to be used for private business use if it subsidizes the repayment of
the bonds with State or local governmental funds, such as generally
applicable taxes. For example, a city could pledge revenues from a city-
wide sales tax, hotel tax, car tax, property tax, or other broadly
based generally applicable tax to pay the debt service on Governmental
Bonds to finance a stadium.
The tax policy justification for a Federal subsidy for tax-exempt bonds
is weaker when State or local governments use Governmental Bonds to
finance activities beyond traditional governmental functions, such as
the provision of stadiums, in which the public purpose is more
attenuated and private businesses receive the benefits of the subsidy.
Certain Tax Policy and Regulatory Authority Considerations Regarding
Tax-Exempt Bond Financing:
A. Targeting the Federal Subsidy for Tax-Exempt Bonds in General:
In general, it is important to ensure that the Federal subsidy for tax-
exempt bonds is properly targeted and justified. A rationale for a
Federal subsidy for tax-exempt bonds for State and local governmental
projects and activities exists when they serve some broader public
purpose. The tax policy justification for a Federal subsidy for State
or local governmental projects and activities is clearest in the case
of traditional public infrastructure projects to carry out traditional
governmental functions where the public purpose is clear, particularly
when the Federal subsidy is necessary to induce the projects to be
undertaken.
The tax policy justification for this Federal subsidy becomes weaker,
however, in circumstances that are more attenuated from traditional
State or local governmental activities, such as circumstances that lack
a clear public purpose justification, provide significant benefits to
private businesses, or involve projects that might have been undertaken
in any event without the benefit of the Federal subsidy
In addition, it also is important to recognize that, in general, the
Federal subsidy for tax-exempt bonds is less efficient than that for
direct appropriations because of the inefficiency of pricing in the tax-
exempt bond market. 1n this regard, since some bond purchasers have
higher marginal tax rates than those of the bond purchasers needed to
clear the market, tax-exempt bonds cost the Federal government more in
foregone revenue than they deliver to State and local governments in
reduced interest expenses. Thus, for example, if taxable bonds yield 10
percent and equivalent tax-exempt bonds yield 7 5 percent, then
investors whose marginal income tax rates exceed 25 percent will derive
part of the Federal tax benefits, resulting in a subsidy to the State
and local governmental issuer that is less than the reduction in
Federal revenue
At the same time, it is important to point out that tax-exempt bond
financing has advantages over the use of appropriated funds by
government agencies The involvement of private investors in the
decision- making process for infrastructure investment can bring with
it greater sensitivity to actual project costs and returns than in
public sector investment decision-making In some cases, this enhanced
sensitivity to project costs and returns may compensate for the
somewhat lower tax efficiency of tax-exempt bonds and lead to a more
efficient investment outcome overall In 2005, the Administration
supported legislation that extended Private Activity Bond authority to
qualified highway and surface freight transfer facilities in the
highway and transit reauthorization based in part on these
considerations
B. Certain Tax Policy Considerations regarding Tax-Exempt Bond
Financing of Stadiums:
From a tax policy perspective, the ability to use Governmental Bonds to
finance stadiums with significant private business use when the bonds
are subsidized with State or local governmental payments, such as
generally applicable taxes, arguably represents a structural weakness
in the targeting of the Federal subsidy for tax-exempt bonds under the
existing legal framework
At the same time, the tax policy justification in favor of the existing
two-pronged Private Activity Bond definition is that it gives State and
local governments appropriate flexibility and discretion to finance
with Governmental Bonds a range of projects in public-private
partnerships with significant private business use when the projects
are sufficiently important to warrant subsidizing them with State and
local governmental funds, such as generally applicable taxes. Here,
political constraints against commitment of such governmental funds
ordinarily serve as a sufficient check against excess financing of such
projects. An argument can be made, however, that this justification
maybe debatable in certain cases, such as in the case of certain
stadium financings.
Several options could be considered to address the possible structural
weakness in the targeting of the tax-exempt bond subsidy relative to
tax-exempt Governmental Bonds for stadium financings.
First, Congress could consider repealing the private payments prong of
the Private Activity Bond definition for stadiums only This possible
change would prevent use of lax-exempt Governmental Bonds to finance a
stadium whenever the stadium has more than 10 percent private business
use, as would typically be the case with any professional sports
stadium This option would preserve the ability of State and local
governments to use Governmental Bonds to finance stadiums used
primarily for governmental use (e.g., stadiums for state universities
or city-sponsored amateur sports) This option would ensure targeting of
the Federal subsidy for tax-exempt Governmental Bonds to circumstances
involving predominant State or local governmental use of stadiums In
its Options to Improve Tax Compliance and Reform Tax Expenditures (JCS-
02-05, January 27, 2005), the Congressional Joint Committee on Taxation
included this option to repeal the private payments limitation for
stadium financings.
Second, Congress could consider combining the first option described
above with an amendment to Section 142 of the Code to allow the use of
tax-exempt Private Activity Bonds to finance stadiums used primarily
for private business use within the constraint of the annual State tax-
exempt Private Activity Bond volume caps. This measured option would
constrain stadiums to compete with other eligible projects for
allocations of this bond volume cap
Third, Congress could consider banning tax-exempt bond financing for
stadiums altogether. In 1996, Senator Patrick Moynihan sponsored a
widely-publicized legislative proposal to this effect, which was never
enacted into law
Fourth, Congress could consider a broader option to repeal the private
payments prong of the Private Activity Bond definition altogether This
possible change would treat bonds as Private Activity Bonds whenever
private business use exceeded the 10 percent private business use
limitation This broader option would have an effect well beyond
stadiums. This broader option would affect all types of projects with
significant private business use that otherwise could be financed
currently with Governmental Bonds based on payments from governmental
funds In its 2005 tax compliance options mentioned above, the Joint
Committee on Taxation also discussed this broader option to repeal the
private payments limitation altogether.
At this time, the Administration does not take a position on any
specific policy option with respect to possible legislative changes to
the tax-exempt bond provisions relative to stadium financings. This
topic raises difficult questions which require balancing the interests
of State and local governments in flexibility to finance projects they
deem sufficiently important to subsidize with governmental funds and
the Federal interest in ensuring effective targeting of the Federal
subsidy for tax-exempt bonds. The Administration recognizes that review
of this important Federal subsidy may be appropriate in considering
ways more generally to simplify this area and to ensure effective
targeting of this subsidy for public infrastructure in order to justify
its cost
C. Certain Regulatory Authority Considerations
The question has been raised whether the Treasury Department has the
regulatory authority to restrict the use of tax-exempt bond financing
for professional sports stadiums. The existing legal framework allows
the use of Governmental Bonds to finance professional sports stadiums
when the bonds are payable from governmental sources of funds, such as
generally applicable taxes. In the legislative history to the present
tax-exempt bond provisions of the Code, Congress clearly stated its
intent to allow Governmental Bonds when secured by generally applicable
taxes The Treasury Department's and the IRS's roles in providing
regulatory guidance are to interpret the Code in a manner consistent
with Congressional intent
Therefore, while the Treasury Department and the IRS have broad
regulatory authority to interpret the Code, neither the Treasury
Department nor the IRS has regulatory authority so broad as to read the
private payments limitation out of the Private Activity Bond definition
under Section 141 of the Code or to disregard Congress' expressed
intent to exclude generally applicable taxes from private payments for
this purpose Thus, we do not believe the Treasury Department has the
regulatory authority to prohibit use of Governmental Bonds to finance
stadiums under the existing statutory structure. 8
Certain Statistical Data on Tax-Exempt Bonds
The Treasury Department estimates that Federal tax expenditures for the
Federal subsidy for tax-exempt bonds grew from about $26 billion in
1998 to about $30.9 billion in 2006 This tax expenditure is estimated
to grow to about $41 1 billion in 2012 Attached to my testimony is
certain statistical data on tax-exempt bonds One chart provides
information on long term new money (versus refinancing) tax- exempt
bond issuance from 1991-2005, derived from IRS Statistics of Income
data, and shows that annual total tax-exempt bond issuance grew from
about $100 billion in 1991 to over $200 billion in 2005 Two additional
charts provide breakdowns of the types of projects financed with
Governmental Bonds and Private Activity Bonds from 1991-2005
Although the Treasury Department has no specific data on tax-exempt
bond usage for stadiums, in a U S Government Accounting Office ("GAO")
Report entitled "Federal Tax Policy: Information on Selected Capital
Facilities Related to the Essential Governmental Function Test" (GAO-06-
1082, dated September 2006), the GAO estimated that, during the period
from 2000 through 2004, approximately $53 billion in tax-exempt bonds
were issued in about 119 bond issues to finance stadiums and arenas
Conclusion
The Administration recognizes the important role that tax-exempt bond
financing plays in providing a source of lower-cost financing for
critical public infrastructure projects and other significant public
purpose activities It is important to ensure that the tax-exempt bond
program is properly targeted so that it works most effectively and that
the Federal subsidy for tax-exempt bonds is justified in light of the
revenue costs and other costs imposed- The Administration would be
pleased to work with the Congress in reviewing possible options to try
to improve the effectiveness of this important Federal subsidy
Thank you again, Mr Chairman, Ranking Member Issa, and other Members of
the Subcommittee for the opportunity to appear before you today. I
would be pleased to answer any questions.
Figure: Governmental Tax-Exempt Bonds by Purpose, 1991-2005:
[See PDF for image]
[End of figure]
Figure: Private Activity Bond Issuance by Purpose, 1991-2005:
[See PDF for image]
[End of figure]
Figure: Long-Term, New Money Tax-Exempt Debt Issuance, 1991-2005:
[See PDF for image]
[End of figure]
[End of section]
Appendix VIII: GAO Contact and Staff Acknowledgments:
GAO Contact:
Michael Brostek, (202) 512-9110 or brostekm@gao.gov:
Acknowledgments:
In addition to the individual named above, Charlie Daniel, Assistant
Director; Terry Draver; Thomas Gilbert; Nancy Hess; Larry Korb; John
Mingus; Ed Nannenhorn; David Perkins; Cheryl Peterson; Katrina Taylor;
and Walter Vance made key contributions to this report.
[End of section]
Footnotes:
[1] Summing the individual tax preference estimates, as is done to
obtain these totals, is useful for gauging the general magnitude of the
federal revenue involved, but it does not take into account possible
interactions between individual provisions. Despite the limitations in
summing separate revenue loss estimates, these are the best available
data with which to measure the value of tax expenditures. Other
researchers also have summed tax expenditure estimates to help gain
perspective on the use of this policy tool and examine trends in the
aggregate growth of tax expenditure estimates over time.
[2] Pub. L. No. 99-514 (1986).
[3] Section 501(c)(3) of the Internal Revenue Code defines the
conditions for nonprofit, or charitable organizations to maintain tax-
exempt status.
[4] States may also allow tax-exempt bond interest to be excluded from
state income taxes.
[5] Notes, commercial paper, certificates of participation, and tax-
increment financing are all different types of financing arrangements
typically used in connection with tax-exempt bonds. Notes have short-
term maturities and are issued to address mismatches in timing of
expenditures and offsetting revenues. Commercial paper is an unsecured
obligation also used to finance short-term credit needs. Certificates
of participation are financing arrangements in which an individual buys
a share of the lease revenues of an agreement made by a municipal or
governmental entity, rather than the bond being secured by those
revenues. Tax-increment financing is a way of pledging some of the
increased taxes that result when property is redeveloped to pay the
costs of associated public investment.
[6] Qualified private activity bonds for small mortgage revenue bonds
and veterans' mortgage revenue bonds are subject to a 3.5 percent limit
on bond proceeds for issuance costs.
[7] AMT is a separate federal tax system that applies to both
individual and corporate taxpayers. It parallels the income tax system
but with different rules for determining taxable income, different tax
rates for computing tax liability, and different rules for allowing the
use of tax credits.
[8] Section 501(c)(3) bonds are issued by charitable organizations that
qualify for exemption under I.R.C. § 501(c)(3). Such organizations must
be organized and operated exclusively for educational, religious, or
charitable purposes, and no part of the organizations' net earnings may
inure to or be for the benefit of any shareholders or individuals.
[9] Although not states or subdivisions of states, Indian tribal
governments are provided with a tax status similar to state and local
governments for specified purposes under I.R.C. § 7871. Among the
purposes for which a tribal government is treated similar to a state is
the issuance of tax-exempt bonds. However, tribal bond issues are
subject to limitations not imposed on state and local government
issuers. Tribal governments are authorized to issue tax-exempt bonds
only if substantially all of the proceeds are used for essential
governmental functions or certain manufacturing facilities.
[10] A bond is being offered in the primary market during its original
sale, where the bond proceeds go to the bond issuer. Bonds being
offered in the secondary market are being traded among investors after
the original sale has taken place.
[11] A third method, referred to as private placement, is less
frequently used. Under the private placement method, the issuer sells
bonds directly to investors.
[12] Numbers are presented in constant 2007 dollars.
[13] From 2001 through 2005, about half of the states, including the
District of Columbia, used their full allocation of tax-exempt private
activity bonds. In total, only about 2 percent of all qualified private
activity bonds subject to annual volume caps were not used by the
states during this period.
[14] We used the Bond Buyer 20-Bond Index, a set of general obligation
bonds maturing in 20 years, to compare interest rates on tax-exempt
bonds over time.
[15] Summing the individual tax preference estimates is useful for
gauging the general magnitude of the federal revenue involved, but it
does not take into account possible interactions between individual
provisions. Despite the limitations in summing separate revenue loss
estimates, these are the best available data with which to measure the
value of tax expenditures and make comparisons to other spending
programs. Other researchers also have summed tax expenditure estimates
to help gain perspective on the use of this policy tool and examine
trends in the aggregate growth of tax expenditure estimates over time.
[16] JCT does not publish estimates for tax expenditures valued at less
than $50 million per year. As a result, JCT does not include estimates
for the revenue loss associated with all qualified private activity
bonds.
[17] Our limited analysis included searching for particular words in
the description that we believed would describe activities associated
with tax-exempt bonds. This included searching for words such as
"pollution," "industrial park," and "stadium," in order to identify a
few of the purposes for which bonds placed into the other category were
used. The data we reviewed do not allow us to make generalizations
about how governmental bonds in the other category are used or provide
us with a comprehensive list of purposes for bonds in the other
category.
[18] We classified the bonds into the eight SOI categories by reviewing
the official statements. We classified bonds that included multiple
uses as other. In SOI's data, bonds classified as other are regularly
used for multiple purposes; however, a single bond issue for multiple
purposes can be classified into more than one category.
[19] To qualify as a tax-exempt 501(c)(3) bond, the property financed
with the bond issue must be owned by the 501(c)(3) organization or a
governmental entity and it must not satisfy both the modified private
business use and modified private payments test. This means that more
than 5 percent of the net bond proceeds cannot be used for any private
business use and more than 5 percent of the payment of principal and
interest on the bond issue cannot be directly or indirectly secured by
payments or property used or to be used for a private business use.
[20] We identified uses for nonhospital 501(c)(3) bonds by matching
two- digit industry codes on the IRS Form 8038 with the corresponding
dollar amounts for the bonds that were issued.
[21] The Tax Reform Act of 1986, Pub. L. No. 99-514 (1986) disallowed
the use of private activity bonds for several types of facilities
allowable under the previously existing laws. Some examples include (1)
development associated with airports including hotels, retail
facilities, office buildings, and industrial parks; (2) small issue
bonds for nonmanufacturing facilities, another type of financing used
for hotels; (3) redevelopment bonds for private or commercial golf
courses, country clubs, massage parlors, hot tub and suntan facilities,
racetracks and other gambling facilities, and liquor stores; and (4)
exempt facility bonds for certain purposes, such as sports facilities,
convention or trade show facilities, and parking facilities.
[22] Gulf Opportunity Zone private activity bonds, authorized in 2004
for rebuilding areas affected by hurricanes Katrina, Rita, and Wilma,
and Liberty Zone private activity bonds, authorized in 2001 to help
rebuild areas affected by the September 11, 2001, terrorist attacks in
New York City, can be used to finance hotels.
[23] Joint Committee on Taxation, General Explanation of the Tax Reform
Act of 1986, JCS-10-87 (Washington, D.C.: 1987), 1161.
[24] 97-1 C.B. 632.
[25] We were able to identify limited information in the SOI data on
golf-related facilities in our review of the other category for
governmental bonds. However, we were not able to use these data to
determine the number of golf courses financed with tax-exempt bonds.
[26] The AAA ratings service is a nationally recognized source of
information on hotel ratings. The ratings range from one to five
diamonds. The definitions of the ratings vary, ranging from basic to
luxurious in terms of service and amenities.
[27] Hearing on Taxpayer Financed Stadiums, Convention Centers and
Hotels, 110th Cong. (Mar. 29, 2007) and Professional Sports Stadiums:
Do They Divest Public Funds From Critical Public Infrastructure, 110th
Cong. (Oct. 10, 2007).
[28] For example, in cases where a bond with relatively complex
features is to be issued during a time period with volatile interest
rates, a negotiated sale might be preferred because in a negotiated
sale the underwriter and the issuer have more flexibility in terms of
the timing of the bond issue, and the underwriter has more time to
search for investors better suited to more complex bonds.
[29] The studies we reviewed generally used multivariate regression
analysis techniques to identify the effect that the method of sale has
on interest costs. Multivariate regression analysis is a research
technique commonly used by economists and other researchers to isolate
the effect of one or more variables on the variable of primary
interest.
[30] Of studies that reported the magnitude of the difference in
interest costs for competitive and negotiated bonds, one found the
difference to be 0.6 percentage points. However, most of these studies
found the difference to be lower, generally ranging from 0.1 to 0.2
percentage points, and two of the studies raised questions about
whether bonds issued through the competitive method of sale have
significantly lower interest costs.
[31] Some debate exists about the appropriate statistical specification
and whether potential selection bias issues need to be taken into
account. In the case of comparing competitive and negotiated bond
sales, potential selection bias may arise from the fact that most bond
issuers can choose the method of sale that they believe will be most
beneficial. Some studies have found either insignificant or relatively
small advantages to competitive sales after taking these potential bias
issues into account, but other studies have found the potential bias to
have little effect on the results.
[32] By law, bond issuers are required to file IRS Form 8038-G,
Information Return for Tax-Exempt Government Obligations for
Governmental Bonds, for bonds with an issue price of $100,000 or
greater, or IRS Form 8038, Information Return for Tax-Exempt Private
Activity Bonds. Generally, these forms are required to be filed by the
15TH day of the second calendar month following the quarter in which
the bonds were issued.
[33] GAO, Federal Tax Policy: Information on Selected Capital
Facilities Related to the Essential Government Function Test, GAO-06-
1082 (Washington, D.C.: Sept. 13, 2006).
[34] Some of the other private vendors are Bloomberg and DCP Data.
[35] Routinely, state and local governments authorize a single bond
issue for multiple facilities and activities because it is more cost-
effective to do so than to issue separate bonds for each individual
project.
[36] The Bond Buyer Yearbook is published by Thomson Financial, one of
several private vendors that collect information on municipal bonds.
The Bond Buyer staff develops the information presented in the Bond
Buyer Yearbook primarily from the Thomson Financial municipal bond
database.
[37] H. Rep. too. 99-841, 99" Cong. 2d Sess. at Page 11-688, 1986-3
C.B. Vol 4 688 (1986) (emphasis added).
[38] In general, the treatment of payments, including PILOTs, as taxes
based on their substance is grounded in longstanding Federal income tax
principles See, e. g., Rev. Rel. 71-49, 1971-1 C B 103 (PILOTs treated
as taxes in substance for purposes of deductibility of taxes under Code
Section 164).
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