The Government Finance Officers Association has reviewed the various proposals to reform the existing federal tax system and has concerns about the impact these proposals may have on the ability of states and local governments to continue to finance their projects with general obligation and revenue bonds for essential government services and to raise revenues. The GFOA urges the Congress and the Administration to recognize that states and local governments are not special interest groups, but are an integral part of the nation's total governmental structure of which the federal government is the other part. Both parts serve the same constituents and must be supported by those same constituents. Therefore, federal policy changes that increase the cost of state and local government will result in reduced services and increased state and local taxes and user charges. In that light, the Association urges consideration of the following statements, which are consistent with all previous policy positions taken by this Association, in any modification of the federal income tax structure:

TAXATION OF INTEREST ON STATE AND LOCAL OBLIGATIONS -- A basic tenet of the federal system of government is the constitutional doctrine of reciprocal immunity. Therefore, the federal government cannot tax the interest on obligations issued by states and local governments and states and local governments cannot tax the interest on federal government obligations. No federal tax should be imposed, either directly or indirectly, on the interest paid on state and local government obligations issued to provide services to the public. Examples of direct or indirect taxation are the imposition of the individual minimum tax on the interest on state and local obligations and the inclusion of tax-exempt interest in the income base of social security recipients.

The use of the term "subsidy" in connection with tax exemption should be discontinued. This term distorts the role of states and local governments in the federal system of government because it treats the interest exclusion as if it were granted merely by Congressional grace rather than as a Constitutional right.

BONDS FOR PRIVATE USERS -- The Association opposes the unrestricted issuance of tax-exempt "conduit" bonds and other bonds that are for the primary benefit of private users. The Association has supported restrictions on these types of financings because of their impact on the cost of borrowing for public purposes, but it believes arbitrary volume caps are not an appropriate way to deal with the issue.

As long as small-issue industrial development bonds, pollution control bonds and other forms of tax-exempt financings for private users continue, suitable restrictions should be imposed in order to limit these forms of financing to specifically defined areas and purposes.

REDEFINITION OF "INDUSTRIAL DEVELOPMENT BOND" -- The present statutory definition of "industrial development bonds" includes not only bonds issued by states and local governments for private industrial development, but also bonds issued to provide essential government services such as airports and water and sewer facilities. The Association supports a redefinition of the term "industrial development bond" to exclude bonds issued for public-purpose projects to remove from those bonds restrictions that are designed to affect financings for private users.

MARKET FOR MUNICIPAL OBLIGATIONS -- The Association opposes changes in the treatment of tax-exempt interest by minimum tax provisions which will diminish institutional buyers' willingness to purchase and carry municipal bonds. The demand for tax-exempt obligations by banks and other financial institutions has decreased because of the reduced profitability of these institutions, the expansion of competing ways to reduce taxable income, and tax law changes affecting the interest expense deduction taken by banks and other financial institutions related to the purchasing and carrying of tax-exempt obligations. Historically banks and other financial institutions have been major investors in municipal bonds.

ARBITRAGE -- The investment of bonds proceeds at market rates for a reasonable period of time pending their application for the purposes of the bond issue is efficient financial management. Arbitrage is the term used to describe the interest earned on invested bond proceeds in excess of the interest being paid on the bonds. It reduces the cost of public projects by reducing the total amount of bonds outstanding for a project. State and local governments should not be penalized for practicing good financial management by being required to "rebate" such investment earnings on the proceeds of tax-exempt bonds to the U.S. Treasury or by the imposition of other restrictions.

CONSULTATION WITH STATE AND LOCAL OFFICIALS -- Proposed legislation and regulations which have substantial adverse impacts on states and local governments in general and the municipal bond market in particular have emanated from the Congress and Administration with growing frequency. Some examples include restrictions on governmental leasing, tax legislation with retroactive effective dates and state-by-state volume caps on municipal bonds.

To afford a better opportunity to solve perceived problems with the minimum disruption of federal/state/local relations, Congress is urged to hold public hearings after the introduction of all tax legislation. Treasury Department officials are urged to have meaningful discussion with state and local officials about problems that are believed to exist before proposing regulations.

Accordingly, the Government Finance Officers Association opposes provisions in pending tax reform proposals, including the U.S. Treasury Department's tax reform proposal, that are inconsistent with the above statements.

• Publication date: May 1985