WASHINGTON - The Congressional Research Service has released a report providing information and revenue estimates for tax-exempt bonds for members of Congress who are likely to examine them and consider curbs in tax reform proposals.
"The tax treatment of state and local government bonds, restrictions on types of activities for which tax-exempt debt can be issued, and activities classifying tax-exempt private activity bonds are areas lawmakers may examine for reform, CRS said in its 15-page report, "Tax-Exempt Bonds: A Description of State and Local Government Debt," released Friday.
"Current legislative interest focuses on altering the tax treatment of state and local debt to provide a more economically efficient subsidy with a lower federal revenue cost," Stephen Maguire, the CRS specialist in public finance, and Jeffrey M. Stupak, his research assistant, said in the report.
Referring to tax exemption as a "preference," the report says: "There are three primary types of proposals that include changes to state and local government bonds - capping the preference, eliminating the preference and changing the preference to a direct issuer subsidy."
"The direction of broader tax reform will likely dictate which modifications, if any, are made to the tax treatment of state and local debt," the analysts said.
The report cited several examples of proposals to curb tax exempt bonds. One is the Congressional Budget Office's "Revenue Options" report released late last year proposing the elimination of tax exemption for new private-activity bonds for a budget savings of $30 billion from 2015 to 2024. Others include President Obama's fiscal 2015 budget proposal to cap the value of tax exemption at 28% and the 2010 Simpson-Bowles deficit reduction plan, which proposed eliminating tax exemption for all mew municipal bonds as part of comprehensive tax reform.
The annual federal revenue loss, called the tax expenditure, on the outstanding stock of tax-exempt bonds issued for public purposes was $28.4 billion in 2013, the CRS report said, citing Office of Management and Budget figures in Obama's FY-2015 budget request. The tax expenditure for private-activity bonds was $10.02 billion in 2013, the CRS said, citing OMB figures in the same document.
The CRS report shows outstanding revenue bonds have outpaced general obligation bonds each year, between 61% and 72% from 1992 through 2013. It also shows that PAB volume has accounted for a relatively small amount of total bond volume from 1992 through 2011, based on Internal Revenue Service statistics.
The report describes why state and local governments issue tax-exempt debt, such as to reduce the difficulty of matching the timing of their revenues and expenditures. "Thus, state and local governments have valid reasons to borrow funds," the report concludes. "In fact, these reasons are so universally accepted that both taxpayers and the courts have ignored the 19th century legacy of unrealistically restrictive constitutional and statutory limitations on state and local borrowing."
The CRS said they are several ways to measure the degree to which tax-exempt debt is favored, compared to taxable debt. The two most common, it said, are the yield spread and the yield ratio.
The yield spread is the difference between the interest rates on taxable bonds and tax-exempt bonds with similar characteristics and risk. Since 1980, the spread between taxable and tax-exempt bonds has declined as underlying interest rates have declined, the report said.
The yield ratio is the average rate on tax-exempt bonds divided by an average rate on taxable bonds with similar terms and risks and it adjusts the spread for the level of interest rates. A lower ratio generally implies a greater savings to state and local governments relative to taxable debt, the report said. The ratio was lowest in 1980 and reached a peak in 2012 for Treasury bonds and in 2013 for corporate bonds, according to the report.
"Since the financial crisis in 2007, the yield ratio of tax-exempt bonds to Treasury bonds has diverged significantly from the ratio of tax-exempt bonds to corporate bonds," the report said. "Investors may be signaling that Treasury bonds and corporate bonds are no longer interchangeable investments."
