WASHINGTON -- The municipal bond industry has mounted a campaign to convince the Treasury Department to adopt a rule that would ease advance refunding restrictions so state and local issuers can benefit from lower interest rates.

But federal officials said yesterday it is questionable whether the Treasury could or would write such a rule.

Under the proposal, which was conceived by investment banking firms, issuers could advance refund bonds whenever the refunding would not result in more than two outstanding bond issues for the same project.

In other words, bonds issued to advance refund an issue could themselves be refunded as soon as the issue that was refunded was redeemed.

"It would save states and localities money," Micah Green, executive vice president of the Public Securities Association, said Tuesday.

The idea, he said, is that state and local governments should be permitted to take advantage of historic low market interest rates to achieve some savings that will free up capital for investment and job creation.

Easing refunding restrictions would be an alternative means of providing state and local officials with funds for investment and job creation now that the stimulus package has been shelved, he said.

Initially, the industry focused on changing the tax law, he said, but once it became clear that the tax bill would not be opened up for amendments, the focus shifted to pushing for a Treasury rule.

Treasury and Internal Revenue Service officials, however, are not sure they have the authority or want to adopt such a rule.

"From a regulatory standpoint, I think it's a real stretch," said one federal official.

A congressional aide was more blunt. "Personally, I don't think Treasury has the authority to do it," he said.

The 1986 Tax Reform Act prohibited most private-activity bonds from being advance refunded and limited the number of times tax-exempt governmental and 501(c)(3) bond issues could be refunded. Under the act, governmental and 501(c)(3) bonds issued after Dec. 31, 1985, can be advance refunded only once and such bonds issued on or before that date can be refunded only twice.

The restrictions were enacted because of concerns that some bond issues were being continuously refunded so that several sets of bonds were outstanding for the same project at the same time, federal and industry officials said.

The so-called Blue Book, the congressional staff's explanation of the tax reform act, says that all refunding issues should be counted in determining whether the one-time or two-time limits are being met.

The federal official said that the industry proposal appears to suggest that "one advance refunding means more than one."

"I think that's a real stretch that is inconsistent with section 149(d)" of the tax law, he said.

Another federal regulatory official agreed, saying, "It would be sort of a rolling refunding rule under which you could always have two sets of bond issues outstanding" for a project.

An additional concern among federal officials and congressional aides is that the proposal would result in huge revenue losses for the federal government.

"The cost of doing this would be very large, probably in the billions of dollars," the federal regulatory official said.

The only way this kind of proposal will fly, he said, is if the industry can convince President Clinton, Treasury Secretary Lloyd Bentsen, or National Economic Council Chairman Robert Rubin to support it and to find a way to pay for it.

Green said that while the proposal was conceived by the broker-dealer community, "it's got to be issuer-driven" to succeed.

Thus far, state and local issuer groups are mildly supportive of the idea or are still considering it.

Catherine Spain, director of the Government Finance Officers Association's federal liaison center, said GFOA supports the proposal, but that it is less of a priority than a handful of other proposals that include obtaining arbitrage rebate relief and increasing the small-issuer rebate exemption.

"In the current interest rate environment, we are concerned about advance refunding restrictions," she said.

Spain said several public interest groups recommended this year, as one of many infrastructure initiatives, that the Clinton administration consider allowing issuers to advance refund bonds when they would achieve a certain level of savings.

Milton Wells, director of the National Association of State Treasurers' office of federal relations, said that he has not yet determined how his members will respond to the refunding proposal.

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