State private activity bond volume caps.

The inclusion of a provision to lift the decade-old volume cap on the issuance of nonhospital 501 (c)(3) bonds in the Taxpayer Relief Act of 1997 sent two important messages to members of the municipal bond market community seeking an increase in the state private activity bond volume cap: 1) Congress is willing to consider adjusting arbitrary caps that hinder investments in public projects and economic growth, and 2) perseverance pays off. Legislation has been introduced in the 105th Congress to increase the state private activity bond volume cap, currently the greater of $50 per capita or $150 million per state. Private activity bond advocates have already set their sights on the next tax bill and are gearing up for what is certain to be a formidable task: convincing federal lawmakers to increase the annual volume cap on tax-exempt private activity bonds.

Status and History of Volume Caps

Within each state, bond authority under the volume cap is allocated among many programs and projects, including affordable single and multifamily housing; manufacturing facilities; environmental, energy, and utility projects; redevelopment of distressed areas; and student loans. Currently, volume cap growth is limited to annual state population increases and does not account for inflation. This has meant a substantial drop in the purchasing power of the private activity bond volume cap over the past 10 years.

Tax-exempt financing through the use of private activity bonds facilitates cooperation between the public and private sectors in providing capital for many important projects including affordable housing and infrastructure facilities that are vital to sustain economic growth. The federal tax code allows certain types of bonds, which Congress has determined serve important policy goals, to be issued on a tax-exempt basis even if more than 10 percent of the bond proceeds are used in the trade or business of a private entity and more than 10 percent of the debt service on the bonds is backed by private resources. These so-called "exempt facilities" include a variety of infrastructure projects such as public transportation facilities, solid waste and hazardous waste disposal facilities, and water and sewerage facilities. Various conditions and limitations apply to the use of tax-exempt bonds for each of these exempt facilities.

Congress established that interest income from industrial development bonds (IDBs) is taxable in the Revenue and Expenditure Control Act of 1968, and defined IDBs by relying on private use and security interest tests. In 1968, the threshold for private use and debt service security was set at 25 percent, and bond issues exceeding the 25 percent tests were generally deemed taxable, though the legislation did create a list of "exempt purpose IDBs," which included airports, air and water pollution control facilities, and facilities for local furnishing of electric energy, gas, or water.

The state...