Issue Brief: Small Issuer Arbitrage Rebate ExceptionUpdated January 2009
The Government Finance Officers Association (GFOA) supports increases in the small issuer arbitrage rebate exception and the elimination of the requirement that an issuer must have taxing authority in order to use this exception. In general, the small issuer rebate exception can only be used by jurisdictions that issue less than $5 million in governmental and 501(c)(3) bonds annually ($10 million for qualified educational facilities). This limit has not been increased since its creation in 1986. The Taxpayer Relief Act of 1997 (P.L. 105-34) eased this limit for certain educational facility bonds. Additionally in the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16), the small-issuer arbitrage rebate exception for school construction from increased from $10 million to $15 million (effective for debt issued after Dec. 31, 2001).
Background
Under current law, issuers of tax-exempt bonds must rebate to the U.S. Treasury arbitrage (excess interest income) earned from the investment of tax-exempt bond proceeds in higher-yielding taxable securities. Governments incur significant costs in the form of attorneys, investment consultants, computer and accounting support, record storage and general management oversight to comply with arbitrage rebate requirements. In essence, this amounts to a higher cost of borrowing for government issuers of tax-exempt debt.
The federal tax code provides various exceptions to the arbitrage rebate requirements. One of the most useful and workable exceptions is the small issuer rebate exception. This exception allows governments that issue a relatively small volume of tax-exempt bonds in a given year to avoid rebating arbitrage proceeds to the U.S. Treasury, and ultimately, reduces their borrowing costs.
The current $5 million annual issuance limit (excluding issuance for school construction projects) has not been increased since 1986. During this time, construction and other infrastructure costs have increased approximately 45 percent, resulting in erosion in the value of the exception. Furthermore, this exception is not available under current law to issuers that do not have taxing authority. Governments often join together to form authorities to respond to common needs and avoid duplication of effort. Many of these authorities do not have taxing power and instead rely on user fees and other charges to cover the debt service on their bonds.
By disallowing this exception for non-taxing jurisdictions, these governmental authorities incur significantly higher borrowing costs. Federal tax law should not penalize efforts by governments to work cooperatively by imposing higher borrowing costs on authorities that do not have taxing power.
Outlook for 2009
GFOA and other state and local government organizations have continuously recommended to Congress that various arbitrage rebate simplification measures should be adopted, including an increase in the small issuer rebate exception to $25 million.
GFOA continues to work with Members of Congress and the U.S. Department of the Treasury to enact significant arbitrage rebate simplification legislation that will provide an increase in the small issuer rebate exception for all governmental issuers of tax-exempt bonds, including jurisdictions that do not have taxing authority. If Congress tackles significant tax reform measures in the 111th Congress, GFOA will support and promote changes in the arbitrage regulations. Related GFOA Public Policy Statements GFOA • Federal Liaison Center • (202) 393-8020 • (202) 393-0780 FAX • Email
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