Chapter 8
p.519
State and Local Bonds
§103 provides that gross income does not
include interest on an obligation of a State or a
local political subdivision.
Lower interest rate is paid on these bonds to
reflect that no gross income inclusion occurs.
Consider the 40% taxpayer: (1) a 10% taxable
return and (2) a 6% tax-free return have the
same net effect to the bond owner taxpayer.
Note:No tax deduction for interest on borrowing
to purchase tax-exempt bonds. §265(a)(2).
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South Carolina v. Baker
p.520
Cf., “bearer bonds” and “registered bonds.”
§149(a) enacted to preclude tax-exempt interest
unless obligation is in registered form.
This restriction is not precluded by application
of: (1) Tenth Amendment to U.S. Const., or
(2) the doctrine of “intergovernmental
immunity” (since this is not a tax on the
“source,” i.e., not tax on the bond issuing state).
No U.S. constitutional right to the states to issue
(federal) tax-exempt interest paying bonds.
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South Carolina v. Baker
Cont.,
p.520
Why require “registration” for state & local
bonds? See § 149(a)(1).
Note, also, §163(f)(1) that no “provision of law
shall be construed to provide a deduction for
interest on any registration-required obligation
unless such obligation is in registered form”
(when debt issued by a non-govt. party).
This limitation is not applicable to (1) debt
issued by a natural person, (2) private debt
issuances, and (3) debt for less than one year.
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Subsidy to Issuers of Tax
Exempt Bonds?
P. 523
§103 allows lower debt financing costs to state
and local governments. But, how (if at all)
should financial relief to these governments be
provided by the Federal Government?
See proposal re the “taxable bond option.”
Federal subsidy would be provided for 35% of
the interest yield on taxable bonds.
Must be general obligation bonds (& not
industrial development or arbitrage bonds).
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State & Local Bond
Interest Limits
See the limits on tax-exempt bond issuances:
1) Private activity bonds - §§141(e) & 142; p.
526; Cf., school bonds to NRG Stadium bonds.
2) Registration requirement, §149; cf., bearer
bonds.
3) Arbitrage bonds - §148; what is the
objective of an “arbitrage” transaction? If an
arbitrage bond exists the benefit of the arbitrage
transaction is to be paid to the U.S. Govt.
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Tax Arbitrage by
Taxpayers Precluded
See § 265(a)(2) – no deduction is permitted for
the interest expense incurred on borrowed
funds used to purchase/carry obligations
producing tax-exempt interest. (Cf., Haverly
case).
How prove the connection between (1) the
borrowing and (2) the acquisition of tax-exempt
obligations?
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Tax Expenditures
p. 531
A “tax expenditure” is functionally a substitute
for a direct U.S. government expenditure –
accomplished through a benefit provided in the
U.S. tax code.
Accomplished through exclusions, exemptions,
deductions, credits, deferrals, etc.
Highest benefit to highest bracket taxpayer.
Query: What is a deviation from the norm
which will be classified as a tax expenditure?
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Tax Expenditure
Baselines
p.534
A tax expenditure is an exception to the
“baseline.” What is the “baseline”?
Baseline is (cf., Haig-Simons definition) a
comprehensive income tax based on the sum of
(1) consumption and (2) the change in one’s net
wealth. Base does include personal exemptions,
standard deductions and the deduction for
expenses in earning income.
Exceptions to this baseline are the economic
equivalent to US Govt. spending programs.
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Important Variances in
Defining Income Tax Base
See pages 535-536.
Income is taxable only when “realized.”
Separate corporate income tax.
Different tax rates/brackets, based on income.
No adjustment (assets & debt) is made for
inflation effects.
Gifts are not income.
Government transfer payments are not income.
Accelerated depreciation is (not) relevant.
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Tax Expenditure Effect on
Investment
p.541
Are the net costs of capital reduced by various
non-normative tax provisions? Consider:
Accelerated depreciation for plant &
equipment.
Deductions for the energy industry (e.g.,
percentage depletion).
The immediate deduction for R&D expenses.
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Substitute for Direct USG
Expenditures?
Is the tax expenditure a mechanism to indirectly
achieve a government subsidy which is not
monitored by the relevant Congressional
Committee? Cf., a direct expenditure analysis.
Is this beneficial to the particular industry when
the subject matter U.S. Congressional
committee does not exercise jurisdiction over
this “indirect” appropriation (or does not want
to exercise jurisdiction)?
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Dynamic Scoring
p. 551
Should the estimation process for tax
expenditures include secondary (i.e., interactive)
spending effects?
Or, should the estimate be done on a static
basis?
Note (p. 551) that JCT revenue estimates are
stated to reflect anticipated behavioral effects of
the proposed tax statutory change.
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Concepts of Income
p.554
Fundamental inquiry in the tax expenditure
context: Are attempts to estimate tax
expenditures based on a faulty premise, i.e., that
a comprehensive income tax base is (is not?)
adequately defined for measurement purposes.
I.e., should imputed income be required to be
included in this income tax base?
Should the requirement of “realization” not be
relevant for this purpose?
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Chapter 8
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