Conclusion We, therefore, strongly urge the Senate Finance Committee to define arbitrage bonds with some particularity and with a definition or an exception in the Act which would permit the University to issue its bonds to aid in the financing of its faculty housing programs. We base this request on two basic premises: 1. The privilege now accorded to State supported universities to issue evidences of indebtedness carrying tax exempt interest extends to indebtedness incurred for faculty housing. 2. Even though generality and simplicity are desirable attributes of a tax statute, the tax law adopted should not create uncertainties and confusion when exposed in the light of real situations. If this Committee accepts these premises, it should accept our request. Edgar F. Shannon, Jr. University of Virginia T. I. R. 840 TECHNICAL INFORMATION RELEASE OF THE U.S. TREASURY DEPARTMENT, INTERNAL REVENUE SERVICE, PUBLIC INFORMATION DIVISION, AUGUST 11, 1966 The U.S. Internal Revenue Service today announced details of its policy of declining to issue rulings that the interest on certain obligations is exempt from Federal income taxation under Section 103 of the Internal Revenue Code of 1951, The policy will contime in effect, pending the conclusion of a study to determine whether such obligations should be considered obligations of States, Territories, possessions, their political subdivisions or the District of Columbia. The study will be directed at obligations issued by these government:d units where a prin cipal purpose is to invest the proceeds of the tax-exempt obligations in taxable obligations, generally United States Government securities, bearing a higher interest yield. The profit received by the governmental units on the difference between the interest paid on the exempt obligations and the interest earned on the taxable obligations is in the nature of arbitrage. The study will not affect obligations issued prior to the date of this release, More specifically, this ruling policy will apply to obligations falling within either of the following two categories: 1. Where all or a substantial part of the proceeds of the issue (other than normal contingency reserves such as debt service reserves) are only to be invested in taxable obligations which are, in turn, to be held as security for the retirement of the obligations of the governmental unit. 2. Where the proceeds of the issue are to be used to refund outstanding obligations which are first callable more than five years in the future, and in the interim, are to be invested in taxable obligations held as security for the satisfaction of either the current issue or the issue to be refunded. The following are crumples of transactions with respect to which no ruling will be issued: First, a State may issue obligations and invest the entire proceeds in United States bonds with similar maturities bearing a higher interest yield. The United States bonds are then placed in escrow to secure payments of interest and principal on the States obligations. The profit on the interest spread accrues to the State over the period of time that these obligations are outstanding. Second, a municipality may immediately realize the present value of the arbitrage profits to be derived over the future by casting the transaction in the following form: It may issue obligations in the amount of $100 million, use $20 million to build schools or for some other governmental purpose, and invest the balance, $80 million, in United States bonds which bear a higher interest yield. The United States bonds are escrowed to secure payment of interest and principal on the municipal obligations. The interest differential is sufficiently large so that the interest and principal received from the United States bonds are sufficient to pay the interest on the municipal obligations as well as to retire them at maturity. Third, a municipality may issue obligations for the stated purpose of refunding outstanding obligations first callable more than five years in the future. During the interim before the outstanding obligations are redeemed the proceeds of the advance refunding issue are invested in United States bonds bearing a higher Interest yield, and such bonds are escrowed as security for the payment of either of the issues of municipal obligations. During that interim period, arbitrage profits based on the interest spread inure to the municipality, The Service made clear that this announcement covers only obligations falling within the two categories described above. Thus, for example it does not cover an issue of obligations where the proceeds are intended to be used to construct a facility even though the proceeds are initially placed in a trust for the security of the bond holders, and invested in taxable obligations, pending their use to meet the construction costs as they occur. Nor does it cover an issue of obligations merely because a portion of the proceeds is invested in taxable obligations and held solely to meet interest payments on the obligations pending the availability of other revenues. CITY OF LOS ANGELES, CALIFORNIA, TO THE UNITED STATES SUBJECT: Objection to Provisions Relating to Tax-Exempt Status of Municipal Bonds in HR 13270 Provisions under Titles III and VI of HR 13270, which affect the tax exempt status of municipal bonds, present a most serious financial threat to the City of Los Angeles, and I strongly urge this Committee to reject these proposals. These proposals constitute an unwarranted interference with the functioning of local government which has been given a constantly expanding role in serving the people of this nation. Furthermore, they come at a time when the larger urban centers are confronted with unprecedented demands for financing essential capital projects. I am well aware that the motivation for this legislation was an attempt to provide a more equitable Federal income tax structure, but if such legislation will result, as I firmly believe it will, in enlarging the local tax burden of the people of Los Angeles and of depriving them of needed public facilities, then I must oppose it. I will not attempt to cover all of the general and constitutional arguments against the adoption of these measures since these points have been or will be ably presented to you by others. My remarks will be directed at the effect of these proposals on the nearly three million people of Los Angeles (and the more than eight million for whom Los Angeles serves as the urban core and nerve center). Hopefully this view from Los Angeles will be relateable to other major population centers in the nation. By way of background, let me state briefly that the City of Los Angeles has relied heavily on the municipal bond market in its rapid development since the close 33-758 - 69 -- No. 11 - 11 of World War II, and has issued over one billion dollars in general obligation and revenue bonds in just the past twenty years. With the assistance provided by this source of financing, the City of Los Angeles has built the nation's largest municipally owned utility providing the total water and electricity needs of the City, a new jet age airport--now the second busiest in the nation, the nation's foremost man-made harbor, a modern sanitation system, a world famous zoo, and many other significant public facilities. How important has the tax-exempt feature of municipal bonds been to these developments? In the case of several projects, lower interest costs available through municipal bond financing provided the economic feasibility for projects which otherwise would not have qualified. Lower interest costs on outstanding debt are the only obvious break the local property taxpayer receives. Local property taxes in Los Angeles have already reached a level where we are constantly seeking alternatives to reduce the burden. Notwithstanding the volume of municipal bond financing the City has engaged in for developmental purposes, the practice has not been abused. The City's bonds by virtue of sound financial management have earned the confident support of bond rating agencies and are considered a prime credit in the municipal bond market. I have seen statements emanating from Congressional and Treasury sources that indicate that the legislation now before you will not significantly affect the municipal bond market or raise interest rates on new issues. This is simply not true. As a matter of fact, the mere announcement by Chairman Mills early this year that his committee was going to consider legislation in this area, proved severely disruptive - 2 to the municipal bond market. The uncertainty this generated as to the course Congress might follow in this field, caused all outstanding bonds in the municipal market to be discounted in value and drove many potential investors for future municipal issues from the market place. Indices of interest rates on corporate bonds and municipal bonds, which historically tend to track one another, suddenly diverged. Acknowledging the difficult money market conditions that have existed this year, we still observed that the rate of increase in municipal interest rates has been more than 3-1/2 times that in the corporate sector. The increase in municipal borrowing costs in the first nine months of this year, as reflected in the indices, has been 26.3%, while costs of corporate borrowing moved up 7.4%. One announcement by the committee chairman, in the course of the committee's hearings, resulted in an historic 25 basis point rise in the municipal bond index in one day. On a $30 million issue of the City's water bonds such a rise in the bond index, equivalent to 1/4% on the interest rate, would have raised borrowing costs on the issue by more than a million dollars. As further evidence of disruption in the municipal bond market, interest rates have now risen beyond statutory interest rate limits for several classes of the City's bonds. As a consequence, we have been unable to issue any airport bonds this year, when it had been our intention to issue approximately $170 million to finance necessary expansion of airport facilities. Millions of dollars in vital local improvement projects in the City have had to be postponed as a result of the effect this legislation has had on interest rates. The Department of Water and Power, which does not have a statutory interest rate limitation, has witnessed interest costs on its bonds increase 20% in the past nine months and interest costs on its short-term - 3 |