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Roundtable Discussion on Federal Tax Issues Relating to Credit Assistance
Tax Issues Related to Federal Guarantees and Transportation Infrastructure
Mitchell Rapaport, Esq., Nixon Hargrave, Devans & Doyle opened his presentation with a discussion of rules and procedures followed by State and local governments when issuing tax-exempt debt. He said that many of the rules and requirements governing the issuance of tax-exempt debt lack specific guidance. He said that in the absence of guidance, bond counsels were required to issue unqualified opinions regarding the tax-exempt status of bond issues.
Mr. Rapaport stated that his presentation would focus on the Federal guarantee provision in Section 149(b) of the Internal Revenue Code, which effectively prohibits the issuance of Federally guaranteed tax-exempt bonds.
Mr. Rapaport reviewed the basic framework of Section 149(b). He said that a bond was considered Federally guaranteed if the payment of principal or interest on the bond was directly or indirectly guaranteed in whole or in part by the United States. He added that the language of this provision was very broad and that to his knowledge there were no regulations or clear guidance relating to this statute.
Though there were few rulings offering guidance on Section 149(b), Mr. Rapaport noted that when Congress added this provision, it had indicated why the statute was necessary. Congress viewed the combination of tax-exempt debt and Federal guarantees as a double subsidy. Moreover, Congress was concerned that by virtue of the double subsidy, Federally guaranteed tax-exempt bonds would be more attractive than U.S. Treasury securities. The proliferation of such bonds could make it difficult for Federal and State governments to raise funds in the bond market.
Mr. Rapaport stated that the Internal Revenue Service (IRS) bases its determination of whether or not a Federal guarantee is present on the underlying economic substance of the transaction. Transfer of risk to the Federal Government is a key element of the IRS analysis. IRS interpretation provided further evidence of the statute's breadth and vagueness.
Mr. Rapaport said that there were numerous exceptions to the Federal guarantee prohibition, most of which were granted to programs in existence when the provision was first enacted in 1984. He added that when Congress decided whether or not to exempt such programs, it carefully weighed policy goals against tax policy implications. Where national policy objectives outweighed tax policy implications, exemptions were granted.
In closing, Mr. Rapaport addressed the question of subordinate lending by the Federal Government. He asked the following question: If the Federal Government takes a subordinate position as a junior-lien lender, does it constitute an implicit guarantee of the private capital markets' senior debt? He responded to his own question by stating that under TIFIA and TICA, Federal participation is limited to 33 percent of total project costs. At this level of participation, Federal credit assistance would not improve the rating of the senior debt to AAA. He said that in his opinion, Section 149(b) was designed to prohibit transactions yielding tax-exempt interest and obtaining a AAA rating as a result of a Federal guarantee. Under this test, the financial products proposed by TIFIA and TICA would not rise to the level of a guarantee.
Discussion
A member of the audience asked whether a Federal standby line of credit would violate the prohibition against Federal guarantees.
Mr. Rapaport responded that as originally planned, the Federal line of credit extended to the Transportation Corridor Agencies (TCA) was to be available for debt service, if necessary, during the first five years of operation. The issuer and bond counsel went to the Internal Revenue Service (IRS) and attempted to obtain a private letter ruling, arguing that the transaction would not result in a Federal guarantee. The IRS, however, was unwilling to issue such a ruling. In response, TCA broadened the purposes for which the line of credit could be used. As a result of this variation, bond counsel was able to conclude that the line of credit did not constitute a Federal guarantee.
A Treasury spokesman stated that Federal policy for credit programs is outlined in the Office of Management and Budget (OMB) Circular A-129. Treasury is generally supportive of the policies established within Circular A-129. Two such policies relate to the subordination of Federal debt and Federal guarantees of tax-exempt debt. The Federal guarantee provision is based in current tax law. The Federal subordination provision is not. The subordination of Federal debt is an evolving tax policy question which is currently under scrutiny. On one hand, the standby line of credit could operate like a guarantee if project revenues are used to retire debt service and Federal funds are used to backfill by paying other operating expenses. In this case, operating revenues are insufficient to meet both project debt service and operating expenses, yet annual debt service payments are still made. On the other hand, the standby line of credit doesn't provide bond holders with recourse in the event of default.
An audience member said that by definition, a Federal guarantee is a promise that the Federal Government will pay bond holders if a project fails to generate sufficient revenues. When the Federal Government is more than a mere guarantor and puts money on the table, bond counsel may view the Federal Government's role as a grantor or lender. By broadening the purposes for which the line of credit may be used, limiting the amount that can be drawn down in any given year, and providing a pledge with no recourse, the Federal role is something other than that of a guarantor.
Mr. Rapaport responded that the pledge with no recourse was an important point. When the Environmental Protection Agency (EPA) began the State Revolving Fund program, it contemplated offering lines of credit for debt service reserves rather than outright grants to local bond issuers. In response, the Treasury in 1988 issued a notice stating that the EPA line of credit would not represent a Federal guarantee.
An audience member said that the most important question to Treasury is how much a program will cost. Grant programs are appealing because the budgetary impact is easily quantifiable. When programs become more elaborate, like those proposed in TIFIA and TICA, they become riskier and more difficult to assess.
A spokesperson for the Congressional Budget Office (CBO) responded to remarks made earlier in the day. She indicated that is was untrue that TIFIA was the first piece of non-tax legislation scored with a tax revenue loss. The CBO has a long tradition of identifying proposed non-tax legislation and submitting a request to the JCT to review it and provide appropriate revenue loss estimates. For example, the Health Care Reform Act of 1993 was scored with a tax revenue loss. Another example of non-tax legislation scored with a tax revenue loss involved the Alaska Power Administration.
A member of the audience asked whether the Federal Government could charge a user fee paid by project sponsors to offset the revenue loss assigned by the JCT.
A CBO spokesman responded that in theory, a user fee would be possible; however, the user fee component would need to be specified in the authorizing legislation.
A member of the audience asked the CBO spokesperson to review the methodology used to calculate the revenue loss estimate assigned to TIFIA.
A CBO spokesperson responded that the official scoring of TIFIA was performed by the JCT, and was based on the assumptions that the program would increase the volume of tax-exempt debt issued and accelerate the issuance of tax-exempt debt. Such activities would result in a tax revenue loss to the Treasury. The $79 million revenue loss assigned to TIFIA was a conservative estimate.
A member of the audience asked if TIFIA was scored with a revenue loss because it is a credit proposal. The Federal-aid grant program and the SIB program arguably increase the volume of tax-exempt debt issued by State and local governments. Why aren't these programs scored with a tax revenue loss?
A CBO spokesperson responded that the decision to score TIFIA was not based on the fact that it involves credit. When the SIB program was originally introduced, it was unclear how State and local governments would use the program. It was thus quite difficult to estimate or assign a tax revenue loss to the program. Now that CBO has a clearer understanding of how the funds are being used, it is reevaluating its original decision to not score the SIB program with a tax revenue loss.
A JCT spokesperson said that the JCT is well aware that State and local governments have limited resources to dedicate to transportation infrastructure. Because TIFIA targets projects with dedicated revenue streams, the program is not likely to displace other projects funded solely with grants. The Federal credit program proposed under TIFIA would, therefore, stimulate additional investment and induce additional tax-exempt debt, which has a tax expenditure associated with it.
A member of the audience asked whether it was reasonable to assume that investors would put funds otherwise used to purchase tax-exempt debt into something taxable instead.
A JCT spokesperson responded that when the JCT scores legislation, it does not assume a 1 to 1 taxable to tax-exempt debt displacement ratio. The displacement ratio is case-specific and based on careful analysis of numerous variables.
