CHICAGO -- An Iowa state senator has proposed selling debt so the state can raise $42 million to comply with a court order requiring payment of retroactive income tax refunds to federal retirees.

But Gov. Terry Branstad is "not interested" in issuing bonds to come up with the money, according to his press secretary, Richard Vohs. The governor will address the matter in his fiscal 1995 budget message, Vohs said.

State Sen. William Dieleman, D-Sully, suggested this week that issuing some form of debt would allow the state to pay the retirees quickly and reduce annual interest rate costs.

"Bonding would be a quick and easy way of getting it done," Dieleman said.

One difficulty is that the Iowa constitution does not allow the state to sell general obligation debt. State Treasurer Michael Fitzgerald said Iowa could try to arrange a one-time exception, but that he did not know how or by who that could be brought about.

All in all, he said, questions raised by the ruling have prompted Iowa to ask the court for a rehearing in hopes of clarification.

"We have a debt. But by the constitution, we can't have debt," he said. "We also have four years to pay. Does that mean we could bond for four to 10 years?" The ruling gives the states four years to pay the refunds.

The issue arose last month, when the Iowa Supreme Court ruled that federal government retirees' refund claims were retroactive and must be paid with interest by the state, according to Carl Castelda, deputy director of the state's Department of Revenue and Finance.

The state should have given federal employees the opportunity to object to the taxes before paying them, the court ruled.

Before 1989, Iowa taxed pensions of federal government retirees but not those of retirees from state and local governments. Iowa has a three-year statute of limitations, so the retroactive claims apply only to income taxes on federal benefits that were assessed between 1985 and 1988, Castelda said. About 34,000 people are supposed to receive refunds.

A federal employee in Iowa brought the suit against the state after the U.S. Supreme Court ruled in 1989 that income tax laws must be uniformly applied on federal, state, and local employee benefits.

State officials have estimated that the ruling on retroactivity will force Iowa to pay $42 million. Interest on the unpaid state income tax refunds is accruing at about 10% annually, according to state officials.

In addition to bonding, the state is considering interfund borrowing and assessing retroactive taxes on state and local benefits, Castelda said.

Castelda said the state hopes that the requested rehearing of the case will clarify how the should come up with the refunds, among other questions.

Gary Streit, attorney for Arlo Hagge, a federal retiree who filed a lawsuit seeking the refunds back in 1991, said that he has asked the Supreme Court to order a district court to oversee repayment of the claims. Court supervision would ensure that retirees' concerns are addressed in any reimbursement plan adopted by the state, Streit said.

The state Supreme Court last month handed down its decision in the wake of a U.S. Supreme Court decision that left states, such as Iowa, to decide how to address tax retroactivity cases.

In June, the U.S. Supreme Court ruled that the 1989 decision in Davis v. Michigan should be applied retroactivity. In the Davis case, the Supreme Court ruled that pensions of federal employee retirees cannot be taxed more than pensions of state employee retirees.

In addition to the estimated $42 million in refunds, Castelda said the state may face raising another $25 million if the state's highest court issues a similar ruling for another case involving corporate taxes.

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