The Private Use of Tax-Exempt Bonds: Controlling Public Subsidy of Private Activity.

• Author: Temple, Judy

Since the early days of the federal income tax, state and local governments have been able to issue bonds at relatively low interest rates because the interest income received by the bondholders is generally not subject to federal taxation. For many decades, states and localities issued tax-exempt bonds primarily to finance the construction of traditional government projects such as roads, bridges, sewers and schools. By the early 1980s, however, the majority of long-term tax-exempt bonds were issued by state and local governments eager to serve as conduits for low-cost funds borrowed in the municipal bond market on the behalf of private entities. Dennis Zimmerman has written an important book that outlines the important economic and public policy issues involved when state and local governments borrow large amounts of money at federally-subsidized interest rates in order to support the private economic activities of individuals, firms, and nonprofit organizations. This comprehensive volume also chronicles and discusses the motivation behind the attempts made by the U.S. Congress since 1968 to limit this type of conduit borrowing. The author has written for a wide audience. Indeed, anyone interested in public economics, public administration, or economic development may want to read this book.

The primary intent of this book is not to question whether or not the federal tax exemption of municipal bond interest should exist. Instead, the author takes the exemption as given and emphasizes the importance of and the inherent difficulty in restricting the implicit federal subsidy to state and local projects that generate benefits that extend beyond the boundaries of the issuing jurisdiction. Students of fiscal federalism generally agree that allocative efficiency can be enhanced if the federal tax-exemption is provided only to projects that generate these spillover benefits. In Zimmerman's book, bonds issued to finance these projects are referred to as "public purpose" bonds. The tax-exemption should not be targeted toward bond-financed projects that do not serve public purposes.

The difficulty lies in the ability or inability of legislators to write laws that distinguish between public and private purposes. Zimmerman excels in his discussion of the attempts made by Congress over the last 25 years to clearly define what constitutes a private versus public purpose. The most restrictive legislation limiting the use of state and local borrowing for...