Education

Congress’s Tax Maneuvers: Disruptions for School-Bond Sales

By J. R. Sirkin — April 02, 1986 9 min read

In Coweta, Ga., 30 miles southwest of Atlanta, there’s an old school gymnasium that nobody uses anymore.

It’s a perfect spot for storing the $400,000 worth of new desks and filing cabinets that the Coweta County Public Schools purchased last month, but won’t install until next fall, when it finishes a districtwide renovation project.

In Canyon, Tex., just south of Amarillo, they don’t have a spare gymnasium. So school officials are squirreling away the costly new air conditioning and heating equipment they bought last month in a transportation shed.

Two districts, thousands of miles apart, facing a common problem: when they tried to float tax-exempt bonds earlier this year to pay for school repairs, they found they had to comply with several costly provisions of a tax-reform bill passed last December by the U.S. House of Representatives, even though the bill is not yet law, and even though parts of it-including the provision that led them to buy equipment months ahead of schedule-probably never will become law.

‘Th negotiate their bond sales in a market unsettled by the House proposal, the two districts had to agree to spend a percentage of the proceeds within 30 days after the sale—thus, the warehoused equipment—and to forego an investment strategy that would have enabled them to leverage the proceeds into more cash.

''It’s ridiculous,” said Bobby W. Welch, the associate superintendent in Coweta County. ‘Tm surprised how Congress can see so poorly. I can’t imagine people on that level making decisions of this type.”

Meanwhile, school districts that could afford to wait to see what would happen in the Senate will fare much better-for the next several months, at least.

Rollercoaster Ride

Late last month, the market for tax-exempt bonds—including school bonds—swung back into high gear, capping a several months-long rollercoaster ride I sparked by Congressional efforts to I limit the issuance of such bonds.

Since the first of the year, most state and local governments have chosen not to issue bonds, rather than comply—as Coweta and Canyon did—with the House-passed bill, which carried an effective date of Jan. 1, 1986. In New York State, for example, school-bond sales were reportedly off by 90 percent, while in Texas districts had postponed more than $100 million worth of bond sales by the end of January.

Only $500 million worth of new school-construction bonds were issued nationwide through mid-March, compared with $4.28 billion in 1985, according to Joseph J. Kelly, vice president of the municipal-data department for the Securities Data Corporation, which maintains national statistics on bond issues.

On March 14, after 10 weeks of inaction, the bond market started to pick up when Treasury Secretary James Baker, House Ways and Means Committee Chairman Dan Rostenkowski, Senate Finance Committee Chairman Bob Packwood, and the committee vice-chairmen, issued a joint statement in which they agreed to delay the effective dates of the House provisions relevant to schools until Sept. 1, or whenever the President signs a tax bill into law.

Less than a week later, however, the bottom again dropped out of the market, when Senator Packwood unveiled a proposal to tax retroactively many of the wealthy individuals who shelter their income in tax-exempt bonds.

Within days, the Senate finance panel, by a vote of 19-to-0, repudiated the Packwood proposal, and bond sellers—freed from both the House provisions and the Packwood threat—entered the market in droves. The state of Georgia, for example, offered a $300-million new issue last week, much of it for school construction mandated under the state’s year-old reform law.

The scene was similar to that of late last year, when schools and other debt issuers flooded the market, trying to beat the Jan. 1, 1986, effective date of the House bond provisions. That activity no doubt contributed to the lull in bond sales in the first few months of this year.

But the delay in effective dates and the temporary shelving of the Packwood proposal will not protect schools-which for the first time in many years are facing a demand for new facilities-from restrictions that are almost certain to be in the final tax-reform plan.

“It’s future issues that could kill us,” said Bruce Hunter, director of federal-state relations for the Council of Chief State School Officers. “If enrollments keep going up, we’ll have a hell of a time.”

And none of what transpired late last month helps districts like Canyon and Coweta, which are bound by the terms of their already-issued bonds and may find themselves raising property taxes as a result.

House Requirements

Coweta and Canyon purchased their equipment months in advance because it was the easiest way to satisfy a provision in the House-passed bill that requires bond issuers to spend 5 percent of bond proceeds within 30 days of sale.

Compliance with the House bill also requires the districts to finish their projects within three years—or the bonds they issue will retroactively become taxable—and prevents them from re-investing bond proceeds at a high rate of interest and keeping the earnings, a common practice known as arbitrage.

The districts lose out in several ways. In the absence of the House bill, they would have bought their equipment at the last possible minute, arbitraging the funds spent on equipment along with other bond proceeds, and using the interest earned to lower the amount of tax dollars needed to repay the bonds.

The Blue Valley Schools in Stanley, Kansas, which issued $21-million worth of bonds in February, estimates that it lost $1.33 million in arbitrage earnings as a result of the House-passed restrictions. In consequence, the district reported that it would have to raise property taxes.

“They’re hurting millions of little people,” said Coweta County’s Mr. Welch.

The losses to districts that sold bonds prior to March 14 could have been greater, because uncertainty about whether the bonds will retain their tax-exempt status tends to drive up their price.

“The investor has to look at the risk,” said Caroline Benn, the director of marketing and public relations for the Public Securities Association, a trade association of bond dealers. “Why should he take a lower rate and then find the bond is not tax-exempt?”

The interest paid on tax-exempt bonds is usually 20 to 25 percent less than that for comparable taxable securities.

The same uncertainty about whether bonds would retain their tax-exempt status led many bond counselors to refuse to certify school-district issues as tax-exempt, fearful that they might be held liable for their decision. Without such certification, districts could not go into the market.

Ironically, many districts that issued bonds may have benefited from the slack bond market, which forced prices down, at a time when interest rates have been depressed generally. But Michael A. Resnick, the associate executive director of the National School Boards Association, asserted that bond prices would have been even lower without the House bill, because of the reduced investor uncertainty. The N.S.B.A. has been leading the fight against the House bond restrictions that affect schools.

Another provision of the House bill would apparently restrict schools from allowing community groups to use facilities built with bond proceeds, but the House appears willing to accept Senate language that would soften that provision.

Prevent Abuses

According to a staff member of the House Ways and Means Committee, the 5-percent rule and the 3-year rule were included in the House bill to discourage districts and other municipal agencies from floating bonds, arbitraging the proceeds, and pocketing the interest earnings without completing the project.

The committee staff member, who asked not to be identified by name, acknowledged that the 5 percent rule was a “bad decision.” The provision is not included in the Senate draft bill.

He said the arbitrage restrictions—which would require districts to refund most of their profits to the federal government—would discourage districts from entering the bond market sooner than necessary, driving down bond prices for all districts.

But Richard B. Geltman, the general counsel for the National Governors’ Association, said the House legislation would do just the opposite, because it curtails issuance by state and local governments of so-called revenue bonds-which the seller pays off with revenues generated by the project built with the bond proceeds, such as a hospital or a power plant.

As a result, he said, state and local governments would probably issue more general-obligation bonds—which are backed by their taxing capacity—and would thus bring them into direct competition with schools, which also issue general-obligation bonds.

Mr. Resnick of the N.S.B.A. added that unlike corporations, “any additional money a district generates through arbitrage is used for public education and is a saving to taxpayers, not a dividend to stockholders.”

Larger Debate

Unfortunately for schools, their unrestricted access to tax-exempt bonds is part of a larger national debate over the merits of tax-exempt financing in general, with the federal government seeking to restrain it and the states trying to expand it.

Central to that debate is the question of who benefits from the issuance of such bonds: the seller, typically a state or local government agency that might use the proceeds to lure an industry away from a rival site, or build a public housing project? Or the buyer, who gets a lower rate of interest but escapes taxation?

The House restrictions on arbitrage, for example, are not aimed purposely at schools, federal officials insist, but at wealthy individuals who purchase bonds rather than taxable securities.

“They think every penny you and I earn should be filtered through Washington,” said the P.S.A.'s Ms. Benn.

More than half of the individuals who invest in tax-exempt bonds earn $39,000 a year or less, according to Ms. Benn. Individuals hold about three-quarters of all tax-exempt bonds; institutions hold the rest.

Clear Loser

In any event, the loser as a result of the expansion of the tax-exempt bond market is clear: the federal government, which loses tax revenues and pays a higher interest rate on treasury bills due to the volume of bonds issued by state and local governments.

State and local governments, which view tax-exempt financing as an economic-development tool, have drastically increased their use of bonds in recent years, issuing some $200-billion worth in 1985. And if interest rates continue to fall, municipalities will want to issue even more to refinance their debt.

Much of the increase in bond issues has been in revenue bonds—specifically industrial-development bonds, which critics say amount to a giveaway to private business.

“It’s just gotten out of hand;" said the House Ways and Means Committee expert on bonds. “Tax-exempt bonds are seen as a free lunch and people hate to give it up.”

To combat the increased use of tax-exempt financing, the House tax-reform bill would cap the amount of so-called “non-essential” tax-exempt bonds that each state could issue. Included would be bonds for nonprofit entities, such as institutions of higher education and private schools.

The Senate version would exclude such groups from the statewide caps.

Opponents argue that the benefit to the federal government as a result of the caps would be minuscule compared to the cost to state and local governments.

A version of this article appeared in the April 02, 1986 edition of Education Week

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