WASHINGTON -- A group of 11 associations representing state and local interests is urging Congress to kill a proposal to simplify tax accounting rules for partnerships, because it would seriously erode the principle behind tax exemption for municipal bonds.

"We believe that what would be gained in simplification from this provision would be far outweighed by what represents a significant policy change in the tax treatment of tax-exempt debt, and we cannot condone it," the group said in letters sent last week to every member of the House Ways and Means and Senate Finance Committees.

The group includes the Government Finance Officers Association, National Association of State Treasurers, National League of Cities, National Association of Counties, and groups representing public power, housing, and sewage authorities.

The provision in question is part of simplification legislation introduced in June by Rep. Dan Rostenkowski, D-Ill., and Sen. Lloyd Bentsen, D-Tex. It was designed to simplify a current law requirement that partnerships include more than 40 tax-related items on tax forms distributed to their partners. The partners, in turn, use the information to prepare their federal income taxes.

In their bill, the two tax leaders proposed simplifying that law by eliminating more than three-fourths of those items, including tax-exempt bond interest, which would be treated as taxable. The proposal would only apply to large partnerships in which tax-exempt income is less than 50% of the firm's assets.

When the provision first caught the attention of the municipal market in August, the main concern appeared to be that some municipal bond underwriting firms are partnerships and hold large amounts of tax-exempts in their portfolios. Market participants had said the provision could prompt the firms to stop buying those bonds.

But the 11 associations said they see a deeper problem, striking at the heart of the municipal bond exemption.

"Tax-exempt interest should retain its tax-exempt character regardless of the amount of a partnership's assets that are tax-exempt securities," the letter states. Enactment of the provision "would represent a serious precedent that could lead to more violations of tax exemption."

The Treasury Department supports the measure as needed simplification, and has said the effect on the municipal market would be negligible. But the associations countered that argument by saying any limitation on the municipal bond exemption, "no matter how large or small, will have an impact on the market for tax-exempt debt, which can only result in higher borrowing costs for state and local governments."

How the tax committees plan to resolve the issue may not be known for some time. Rep. Rostenkowski and Sen. Bentsen earlier this year appeared to want to pass the simplification bill in 1991, but they have made no move to bring it before their panels and have made no plans to do so in the last weeks of this year's congressional session.

But association members said it was still important to make Congress aware of their strong opposition to the provision, so the issue could be ironed out well before lawmakers take action on the bill.

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