WASHINGTON -- In its perennial incursions into the tax-exempt market, Congress lately has been entertaining proposals that would crimp the demand for municipal bonds -- rather than restricting the supply by reining in which issuers could sell municipals.
A steady stream of demand-curtailing proposals have been put before lawmakers, and municipal bond proponents are wondering whether the flow is going to slow to a trickle, or turn into a flood.
None of the ideas have been enacted so far, but they are disturbing to the municipal market all the same. The proposals include expanding Individual Retirement Accounts, opening up investment opportunities for nuclear decommissioning funds, changing tax rules for securities firms, taxing unearned income, and allowing more people to use U.S. savings bonds to save for college.
Demand-side problems are not new, said Catherin L. Spain, director of the Government Finance Officers Association's federal liaison center, but now these proposals "come at you faster, more frequently, and from more directions."
Milton Wells, director of federal relations for the National Association of State Treasurers, sees the same problem. "We definitely have to be more on guard [against attacks on] the demand side," he said.
One thing is certain, lobbyists say: Assaults on the demand side of the municipal market by and large are not conscious efforts to restrain tax-exempt bonds.
But that is small comfort to some.
"The effect is the same, whether you're the intended victim or you just happen to be standing nearby," Mr. Wells said.
So what's behind this trend? There seem to be two main reasons why demand-side proposals are appearing with increasing frequency. One is the burgeoning federal budget deficit, which has prevented members of Congress from proposing new programs unless they can come up with ways to pay for them.
All the Wrong Places
"You've got this drive for revenues," said Amy K. Dunbar, the director of governmental affairs for the National Association of Bond Lawyers. Legislators "are looking for new places to try to find ways to pick up money."
A key example is a proposal for mark-to-market tax reporting by securities firms. The proposal would require securities firms, for tax purposes, to report the market value of municipal bonds and other securities they hold in their inventories.
Bond industry officials have warned the proposal could cause firms to dump large amounts of tax-exempts at the end of a year to avoid tax losses. Yet the House and Senate tax committees each included the proposal as a revenue-raising item.
Though the legislation containing mark-to-market requirements was later vetoed by President Bush, the proposal has since found its way into other pieces of legislation, such as a bill to extend emergency unemployment benefits and a plan to create urban enterprise zones.
The reason, simply, is money. Marking to market would raise more than $2 billion for the federal government over the next five years, an extremely tempting carrot to those lawmakers proposing expensive programs.
Securities firms already must mark to market for a accounting purposes, but for tax purposes they are permitted to choose whether to report the market value or face value of their securities.
The second reason why demand-side proposals seem to be more prevalent in Congress is because Washington is searching for ways to encourage Americans to put more money aside for the future.
"There's a growing a feeling that you have to do something about the savings rate in the country, and that's where many of those things stem from," Mr. Wells said. "This isn't all that much a new trend, but it certainly is a continuing problem."
Most savings proposals have focused on expanding the Individual Retirement Account. President Bush and Sen. Lloyd Bentsen, D-Tex., among others, favor giving taxpayers a new IRA option by allowing them to forego the upfront tax deduction usually associated with IRAs and instead "backload" their tax break.
Under this option, interest earned on deposits would be tax-exempt as long as the deposit was left in the account for a certain period of time.
Municipal market participants said they are concerned the accounts would become a sort of "super" Treasury investment that presumably would carry a higher rate than municipals and also have the added value of being exempt from federal taxes.
President Bush and Sen. Bentsen have repeatedly offered their IRA proposals to Congress, but so far neither has become law, mainly because they would cost the federal government a large amount of money.
Municipal bond proponents have become increasingly deft at mounting a counterattack against harmful demand-side proposals, lobbyists said. Their main weapon is education: That is, they have worked to make lawmakers realize that tax changes may inadvertnetly hurt tax-exempt bond demand.
The result is that "members of Congress have come to understand the problem better," said William J. Daly, a lobbyist for New York City.
Municipal lobbyists, for example, have been expressing their concerns to Congress for several years about the proposals to expand IRAs, but it was not until this year that lawmakers responded in a concrete way. Earlier this year, when the Senate Finance Committee approved a tax package that included Sen. Bentsen's IRA proposal, it also approved a measure to increase the supply of bank-qualified bonds.
Under current law, banks may deduct 80% of the cost of carrying tax-exempt bonds only if they are purchased from issuers who expect to sell less than $10 million annually. The committee proposal would have raised that limit to $25 million, though House-Senate conferees scaled that level back to $20 million. The tax package was later vetoed by President Bush.
The most recent indication that lawmakers are paying attention to the municipal market's demand-side concerns is the House Ways and Means Committee's decision to approve an increase in limits on bank-eligible bonds.
The provision, added by the committee to a comprehensive energy bill, was sponsored by Rep. Beryl Anthony, D-Ark. Rep. Anthony said he proposed the bank measure to offset the efects on the municipal market of an amendment by Rep. Richard Schulze, R-Pa., that would ease investment restrictions on nuclear decommissioning trust funds.
Rep. Anthony failed in his bid to win reelection to Arkansas' fourth congressional district seat, losing a Democratic primary run-off on June 9.
Under current law, investments by the funds are limited to Treasury securities, municipal bonds, and bank deposits. But rep. Schulze's amendment would waive all investment restrictions on the funds, which are expected to accumulate substantial amounts of money in the coming years.
Anthony, We'll Miss You
According to some estimates, the funds are now about 80% invested in municipals. Costs for decommissioning the more than 100 nuclear power plants around the country are estimated from $60 billion to $100 billion.
The committee's approval of the provision "was a very positive response to a [potential] demand problem," Ms. Dunbar said.
"The fact that it was included as an offset is essentially a reflection [that] legislators are aware that we do have a market that is not diversified now, and they have to be responsive to our demand-side concerns," she said.
A big part of that responsiveness is Rep. Anthony himself, who has tended to be the tax committee member who alerts other members of Congress to problems for the municipal market caused by tax legislation.
These narrow, demand-side intrusions appear to be less alarming than the constant threats to whole sectors of the market -- such as the perpetual danger of losing the exemption for mortgage revenue bonds -- but to date, the biggest blow to the municipal market actually was demand-driven: The 1986 tax act effectively killed most institutional interest in tax-exempts.
Further, if retail investors are shunted into other investments, it would erode the municipal market's final frontier.
Municipal bond proponents, as a result, have their work cut out for them, and the job can only get tougher after this year, when Rep. Anthony leaves Congress.
Lobbyists said the campaign they have waged to educate members of Congress will go a long way when future tax bills are drafted. Although tho proposals to curb demand for tax-exempt bonds will continue unabated, the lobbyists said, they have the ability to neutralize them.
They're going to need it. Ms. Spain pointed out that the nuclear decommissioning proposal could have snuck through.
"That thing would have slipped right by," she said. "We would have lost if there hadn't been somebody sitting there."
