When it comes to issuers; arbitrage earnings, grinch has nothing on the IRS.

Call it the "The Nightmare Before Christmas." Or maybe, "How the Grinch Who Stole Christmas."

The numbers are in.

The Internal Revenue Service is projecting it will have received a whopping $305 million in arbitrage earnings from state and local bond issuers before the end of the year.

Like a cruel Christmas prank, the end of the year makes clear that once again, the arbitrage requirements taketh from states and localities and giveth to the federal government.

The $305 million this year tops the $291 million in arbitrage earnings that issuers rebated to the IRS last year.

Altogether, the IRS has raked in more than $800 million in arbitrage earnings from state and local issuers in the seven years since the rebate requirements took effect.

That's about $300 million less than the $1.1 billion the Government Finance Officers Association estimated issuers would spend hiring consultants, setting up recordkeeping systems, and doing whatever else was needed to comply with requirements the first five years they were in effect.

Critics of rebate have long contended that the cost of compliance for issuers exceeds the revenues gained by the government.

The IRS numbers seem to support their claim, if the association's cost estimates are accurate.

If having to give to the federal government isn't painful enough, issuers should consider this recent observation by a federal official: "What the $305 million in arbitrage rebated per year really shows is that it's going to be very expensive to make tax law changes to ease bond restrictions."

That's right. You heard him.

Consider, for example, a hypothetical proposal that would allow 10% of all outstanding bond issues to escape the rebate requirements, he said.

Based on the current amount of arbitrage earnings being rebated annually, that proposal would translate into a $150 million loss in federal revenues over a five-year period - $30 million per year.

That's no small change.

But the $150 million figure doesn't even take into account the additional federal revenue losses that would be associated with removing some constraints preventing issuers from issuing bonds early, or in a greater amount, or for longer than necessary, he said.

Of course, the big question is whether state and local bond issuers will continue to contribute to the federal coffers at the rate of about $300 million per year.

That's a tough call, according to most market observers.

Let's assume that most of the arbitrage earnings rebated this year was from long-term fixed-rate bonds issued in 1988. This year would mark the end of the five-year computation period for those bonds. The tax law requires issuers of long-term fixed-rate bonds to compute and rebate arbitrage earnings at least every five years.

Since the volume of new money issues increased steadily from 1988 to 1991, one might assume that the amount of arbitrage earnings to be rebated to the federal government will also rise during the next few years.

However, interest rates have declined, and the spread between long-term tax-exempt and short-term taxable rates has widened. So issuers did not gain as much arbitrage earnings from their bonds during that period. In fact, some issuers reported losing money because they were forced to invest their bond proceeds at a yield well below their bond yield.

In addition, the two-year rebate relief law took effect at the end of 1989. The law exempts from rebate requirements governmental and 501(c)(3) bonds that finance construction if most of the proceeds are spent over a two-year period, according to a series of six-month spending targets.

So issuers may be rebating less arbitrage earnings in the future.

But this year, they gave a lot to the federal government.

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