The municipal securities market is a national asset that has served investors and issuers well for many years, and it should continue to do so in the future.
However, given the infrastructure problems faced by state and local governments in the 1990s, it better work well. Any reasonable mechanism that could provide more capital and increased liquidity to the municipal securities market, and thus result in lower borrowing costs for issuers, should be considered.
News stories abound with large, even astounding, infrastructure investment needs for the United States. Various political groups have claimed public capital shortfalls of hundreds of billions of dollars. While it is difficult to assess these infrastructure need claims, the recent flood in Chicago and riot in Los Angeles lend credence to the notion that there exists an infrastructure crisis.
Most municipal bond offerings are intended to supply proceeds to fund infrastructure capital requirements. As was pointed out in "The Report of the Anthony Commission on Public Finance," since 1917 the tax code has contained provisions encouraging banks to purchase the debt of state and local governments.
The tax code recognized that since banks are in the business of borrowing money to make loans, they should be exempt from the general requirement that borrowing costs associated with tax-exempt debt cannot be deducted from gross income.
Further, these provisions recognized that banks are uniquely suited to purchase the securities of state and local governments in communities in which they are doing business because they understand both the issuer's needs and their creditworthiness.
As a result of these provisions, until 1982 banks played a vital role in the tax-exempt market. However, in 1982 Congress began to limit the bank interest deduction for carrying costs associated with tax-exempt debt, reducing the deduction to 85% in 1982 and then to 80% in 1984 and finally eliminating it for most issuers in 1986.
The Tax Reform Act of 1986 limited the ability of banks to deduct 80% of the cost of carrying tax-exempt bonds so that the deductions were available only for bonds purchased from an issuer that expects to sell no more than $10 million annually.
The impact of these tax code changes on the holding of tax-exempt bonds by banks has been staggering. In 1980, commercial banks held 41% of all tax-exempt securities. But by the end of 1991, bank holdings had dropped to only 9.6%.
In particular, the Tax Reform Act of 1986 sapped an already depressed appetite for tax-exempt bonds on the part of commercial banks. Commercial bank ownership of tax-exempt securities decreased by $128.1 billion, or 33.7%, from the end of 1985 until the end of 1991.
For whatever reason, it is clear Congress has discouraged banks from assisting in meeting public infrastructure needs. Revenue does not appear to be the reason, or at least not a sound one. The final estimate of the Joint Committee on Taxation forecasted a $55 million revenue increase over the first five years following the enactment of the provision in the Tax Reform Act of 1986 amending the bank deductibility limit.
All is not lost, however, Rep. Beryl Anthony of Arkansas inserted an amendment in the energy bill that recently passed the House to increase the current $10 million small-issuer exemption to $20 million.
Unfortunately, the Senate version of the energy legislation does not contain a similar provision. Apparently, the Joint Committee on Taxation has estimated that the Anthony amendment would result in a $69 million revenue decrease over five years. While it is difficult to correlate the two revenue estimates, the small numbers involved continue to indicate that revenue lost or gained is not the motivator for the policy shift.
While the Anthony amendment is a step in the right direction, it does not go far enough. The tax code should be amended to return the bank tax-exempt deductibility provision to at least pre-Tax Reform Act of 1986 status.
The resulting increased capital and additional liquidity provided to the municipal securities market should result in lower borrowing costs, which, in turn, should help state and local governments tackle their infrastructure needs.
Arguably, the enactment of such an amendment would be more helpful in solving the infrastructure crisis than the current proposal to extend tax-exempt treatment to costs to improve defined "enterprise zones." It would also encourage banks to return to the business of community lending, which, hopefully, would lead to a return to community prominence for banks.
By returning banks to a prominent role in the municipal securities market, banks can help meet public infrastructure demands. Banks should be encouraged to contribute to the solution of the public infrastructure crisis. For certain, Congress should return the tax-exempt bank deductibility provision to its pre-Tax Reform Act of 1986 status.
Richard Roberts sits on the Securities and Exchange Commission. The views expressed here are his and do not necessarily represent those of the commission, other commissioners, or the staff.