WASHINGTON - Clean water legislation pending in the Senate would impose expensive new unfunded federal mandates on states and might force them to use their revolving loan funds in ways that would jeopardize the tax-exempt status of their bonds, state officials warn.

The Clean Water Act reauthorization bill scheduled for consideration before the Senate Environment and Public Works Committee this spring would expand the universe of projects eligible for revolving fund loans to $334 billion from an estimated $200 billion, according to the Association of State and Interstate Water Pollution Control Administrators.

The new requirements would come as federal funding for the program has been slashed to $1.2 billion - its lowest level ever and half the $2.4 billion yearly high during the 1980s. Program advocates say the most they can hope for in next year's budget is $2 billion.

New unfunded mandates that would be imposed under the bill, the association said, include an estimated $60 billion to clean up runoff or "nonpoint pollution" from farms and cities, $10 billion to clean up estuaries, $34 billion to construct watershed management projects, $10 billion to contain animal waste, and $20 billion to control water pollution along the Mexican border.

Beyond that, the association was not able to estimate the cost of some new requirements for cleanup of lakes and groundwater because of incomplete information, said Roberta Savage, the association's executive director. She outlined the association's estimates in a letter last month to Sen. Robert Graham, D-Fla., the chairman of the committee's subcommittee on clean water, fisheries, and wildlife.

One of the bill's authors, Sen. John Chafee, R-R.I., has asked for documentation of the association's estimates, which are based on a combination of statistics and educated guesses by water pollution control officials in each of the states, Savage said. Deborah DeYoung, the environment committee's spokeswoman, said the panel has also requested an independent analysis of the bill's costs.

Savage said state officials have had several discussions with the committee staff in recent weeks in hopes of resolving their concerns. A new draft of the bill is expected next month and may show whether the discussions paid off, Savage said

DeYoung said the, staff has been "significantly. reworking" the bill as a result of meetings with state groups and hundreds of other interested parties. Though she wouldn't provide specifics, she said that Graham, in particular, "is quite adamant that the bill be practical and workable" for the states.

Sponsors of the bill have said one of their principal goals in dramatically expanding the clean water mandates is to force states to expand the use of their revolving funds to finance a new universe of less conventional projects, such as runoff controls. Until now, the funds have generally been used to finance traditional municipal wastewater treatment projects.

A substantial amount of the nation's water pollution problems are caused by runoff and other newly defined pollution categories and are concentrated in lakes, estuaries, and groundwater where cleanup can be difficult and expensive. But only a small fraction of the $8 billion of loans made by the revolving funds in the 50 states and Puerto Rico has financed such projects, state officials said.

As the states turn their attention to the new problems, they are finding that the polluters involved and in need of financial assistance, often are private persons or concerns, such as farmers and even Fortune 500 companies, said Linda Eichmiller of the association.

But if the states were to provide a large number of loans to such polluters through their revolving funds, as the bill appears to require, that could threaten the largely tax-exempt status of bond offerings by the funds, she said.

By providing loans to private persons or firms, states could violate the so-called 10% test in the tax law in which no more than 10% of the proceeds of a bond issue can be used by a private party and no more than 10% of the debt service can be derived from or secured by a private party.

States also could violate a provision of the Tax Reform Act of 1986 that says that private loans may not exceed the lesser of 5% or $5 million of a bond issue's proceeds, Savage said.

"The bill gets very prescriptive and they want to push funding of the private sector, but all the private eligibilities would endanger the tax-exempt status of the revolving funds," Eichmiller said.

Steve Grossman and Greg Smith of the Ohio Water Development Authority agreed that the bill's new requirements eventually could pose tax law problems for the states, particularly if they do a lot of bonding through their funds.

According to a recent survey by the authority, 35 states have issued bonds either to fulfill a 20% state matching grant requirement or to augment their federal grants through leveraging of their revolving funds. Only 15 states and Puerto Rico have not issued bonds in connection with their funds.

About $3.1 billion of the bonds to date have been issued to leverage the funds and $870 million have been issued for matching grants, the Ohio officials said. Twenty states have sold general obligation bonds to fill their funds, while 28 states have issued revenue bonds that are backed by loan repayments from the revolving funds.

While a growing number of private borrowers from the funds could pose tax law problems, Grossman and Smith said such tax issues so far have not cropped up for states which have financed private projects through the funds.

The Ohio authority recently avoided jeopardizing its 16.66% of capitalization funds derived from a tax-exempt revenue bond issue by arranging to use other money in the fund to provide a subsidized loan to a farmer, Smith said. The fund invested the money in a certificate of deposit at a bank at a reduced interest rate in exchange for the bank providing the farmer with the loan.

Grossman said that states should be able to devise such "creative" solutions to avoid tax law problems in the future, but the Senate legislation must be written with enough flexibility to permit them to do so.

Terry Agriss, president of New York's Environmental Facilities Corp., which has issued $1.2 billion of tax-exempt bonds to augment its $800 million in federal grants, agreed that complying with the tax laws should not be a problem for states so long as the legislation continues to provide them with sufficient latitude.

To avoid the administrative difficulties of complying with the tax laws, the New York fund has chosen to issue $130 million of revenue bonds on a taxable basis to provide funds for its state match, Agriss said.

If the number of private borrowers from the funds becomes significant, she said, states can always comply with the tax laws by using some of their authority under the state private-activity volume caps to issue the bonds, she said.

"There have been instances where we have looked at private-activity issues with the fund and we are comfortable that they can be accommodated," Agriss said, noting that the New York fund may finance a private-activity project next year.

While the tax law problems should be solvable as states expand their programs to cover private borrowers, Agriss said that more practical problems may prove to be a barrier. In particular, the law "may require us to consider some novel issues" that may not produce a revenue stream sufficient to cover debt service, she said.

The funds' traditional municipal borrowers, by contrast, have usually been strong credits producing reliable revenue streams. "All of us want to be careful that any new types of financing that we're doing for nonpoint source projects would not interfere with our creditworthiness," Agriss said.

Susan Weil of Lamont Financial Services, an investment firm specializing in revolving funds, said she doesn't believe the increase in private borrowers will become a problem unless the federal government enforces the proposed new mandates in a way that drives private borrowers in droves toward the funds.

DeYoung said she is sure that any potential tax law problems are on the Senate committee's "radar screen" as it redrafts the bill. She said that the committee's new chairman. Max Baucus, D-Mont., wants to better coordinate the committee's environmental and tax policies with those of the Senate Finance Committee. Baucus is the second-ranking Democrat on the finance panel.

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