ORLANDO -- President Bush's executive order on privatization will have little or no effect unless Congress enacts major tax incentives for businesses to buy assets from states and localities, a Wall Street official said Saturday.

"I would submit to you that unless you reopen the tax code, the Pandora's box, you're not going to see a lot of private capital being attracted to this business," said Joseph Giglio, managing director of Smith Barney, Harris Upham & Co.

Mr. Giglio, speaking during the Government Finance Officers Association's annual conference here, was referring to the President's April 30 order that is designed to encourage municipalities to privatize publicly owned facilities.

The key feature of the order is a provision that could sharply increase the amount of money state and local governments would be allowed to keep when selling off assets financed in part by federal grants.

The order restricts the amount the federal government would recover in such a sale to the grant money disbursed less accumulated depreciation. Before the order, the federal government had the right to claim a large portion of the proceeds from the sale of assets.

But even though that change will make municipalities more willing to sell, the private sector may not be eager to buy their assets, Mr. Giglio told the association's governmental debt and fiscal policy committee.

For many types of assets that would be sold, "for the first 10 years [after sale] you're looking at operating losses," Mr. Giglio said. "Where's the market for these kinds of operating losses?"

Before 1986, particularly in the housing area, tax incentives existed for business losses suffered in the acquisition or improvement of property. But the Tax Reform Act of 1986 did away with those tax breaks, leaving little motivation for businesses to incur the kinds of losses they would suffer when buying publicly owned facilities, Mr. Giglio said.

"I think you have to ask yourself, can you make the kind of money necessary to get the kind of returns that are needed to attract capital in a regulated environment?" he said. "I continue to remain skeptical."

Karen Hedlund, a partner with the law firm of Skadden, Arps, Slate, Meagher & Flom discussed another concern about the privatization order is that it could create so-called change-in-use problems for state and local issuers.

Under current IRS rules, bonds issued to finance projects might no longer be tax exempt if there is a change in the use of those projects that either benefits private parties or leads to activities that do not qualify for tax-exemption.

Until last year, the IRS had taken a hard line on such situations by concluding in at least four private letter rulings on proposed transactions that bonds would no longer be tax exempt if there was a change in use in the projects they had financed. But last March the IRS eased its stance in another letter-ruling that said that a utility's bonds would remain tax exempt -- even if it merged with a bigger utility so that its bonds technically no longer qualified for tax exemption -- as long as it defeased the bonds at the first call date.

An American Bar Association committee has asked the Treasury Department to consider adopting rules allowing a change in use of bond-financed facilities under certain circumstances if bonds are defeased or are used to purchased other facilities that qualify for tax-exemption. Treasury and IRS officials have said they are considering this proposal.

Ms. Hedlund asserted yesterday that the rules could be changed so bonds would not have to be called if a privatization sale is made. The Treasury could allow the bonds to remain outstanding "if the state or local government takes the proceeds and reinvests those proceeds in other infrastructure that would otherwise qualify for tax-exempt financing," Ms. Hedlund said.

The Treasury could stipulate that "if that condition were met tax exemption of outstanding bonds should not be affected," she added.

High-level Treasury officials have said that one of their priorities is to issue guidance within a year spelling out when changes in the use of bond-financed property or facilities will jeopardize the tax-exempt status of the bonds.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.