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. “States rights” issue?
A 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 taxpayer/bond owner.
Note: No deduction for interest expense on borrowing to purchase tax-exempts. §265(a)(2),
South Carolina v. Baker
Cf., “bearer bonds” and “registered bonds.”
§§ 103(b)(3) & 149(a) enacted to preclude tax-exempt interest unless obligation is in registered form. This restriction is not precluded by:
(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 state issuing bond).
No U.S. constitutional right to the states to issue (federal) tax-exempt interest paying bonds.
South Carolina v. Baker
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.
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 (IDBs) or arbitrage bonds).
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 as not permitting exclusion from income.
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.
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 re “whipsawing”).
How prove the connection between (1) the borrowing and (2) the acquisition of tax-exempt obligations?
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”?
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.
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.
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.
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)?
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.
Concepts of Income
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?