Issuers of tax-exempt debt believe a provision in federal tax legislation passed by the House late last month will boost healthcare financing costs.
It would do that, they say, by eliminating a corporate tax deduction that has helped fuel the sale of municipal securities for many years. Without the deduction, some corporations will stop buying short-term and variable-rate tax-exempt debt, opponents of the measure predict. If demand for those securities were to shrink, rates would become more volatile and tax-exempt issuers' financing costs would rise, the argument goes.
All types of municipal issuers, including organizations that issue tax-exempt healthcare debt, would be affected. The National Council of Health Facilities Finance Authorities is among a coalition of groups, mostly representatives of state and local governments, that oppose the measure.
Under current tax law, most investors are barred from deducting interest costs on money they use to buy tax-exempt securities. That would be considered a double tax break.
But since 1972, the Internal Revenue Service has maintained a "safe harbor" for corporations whose tax-exempt holdings don't exceed 2% of total assets. Known as the "2% de minimis rule," the provision allows most corporations, except for banks and other financial institutions, a small tax break on interest expense incurred when they borrow money to finance the purchase of tax-exempt securities.
The Clinton administration proposed striking the tax loophole as part of the federal government's fiscal 1998 budget. The action is supposed to raise $113 million over five years.
"Essentially, the elimination of this provision would raise some money for the federal Treasury, and that is the suspected reason why people thought the president proposed it," says Ed Fox, director of government affairs at the law firm Mintz, Levin, Cohn, Ferris, Glovsky and Popeo in Washington. It's also why House Ways and Means Committee Chairman Rep. Bill Archer (R-Texas) adopted a form of the proposal, says Fox, who represents the National Council of Health Facilities Finance Authorities.
The House version allows corporations to hold up to $1 million in tax-exempt debt without running afoul of the ban on tax-exempt interest-expense deductions. But opponents say that's peanuts to a corporation with billions in assets and likely would drive many corporations out of the tax-exempt market.
The Senate hasn't taken a position on the issue, finance sources say.
The Treasury Department says eliminating the de minimis rule would not significantly affect municipal borrowing rates, since corporations hold just 5% of outstanding tax-exempt bonds. But Fox contends the municipal market would most certainly feel the cumulative impact of corporations pulling out of the tax-exempt market.
Depending on seasonal demand, municipal issuers' costs could rise from 20 to 70 basis points, says Michael Decker, vice president of public policy in the Washington office of PSA, The Bond Market Trade Association.
Decker says the measure would have an even greater financial impact on tax-exempt organizations that lease equipment.
For cash-flow reasons, equipment-leasing companies generally sell tax-exempt leases to private investors, such as corporations. But if corporations stop buying those contracts, leasing costs would rise an estimated 200 to 300 basis points.
"In the end, I think it's going to hurt municipal tax-exempt bond issuers . . . because they're going to face at least marginally higher financial costs," Decker says.