Mr. PATTERSON. If the Senator please, the State of South Carolina would be vigorously opposed to any such arrangement. There would be all sorts of redtape, and like up in Washington to try to get these unsold or try to get this subsidy, there would be all sorts of priorities as to district, and as to a district in South Carolina, a small district, for example, would want to issue a school bond and the Federal Government agency would probably say: "No; some district in California comes before you, so, therefore, you have got to wait."

A district in South Carolina may want to issue, for example, hospital bonds, and the Government would say: "No, we think you ought to issue some sewer bonds instead.”

There would be all sorts of redtape and unwarranted delays and we are unalterably opposed to any such arrangement in South Carolina.

Mr. GOLDBERG. Senator, the Municipal Finance Officers Association specifically considered the possibility of guaranteed plans and rejected it for the reasons basically that Mr. Patterson just expressed. Senator JORDAN. Thank you.

Mr. HERBERT. If I might make one comment, the gentleman from Hawaii was talking about supporting the plan where the Government would pay us 30 percent of interest cost to the State and local government. Well, we have often been comparing municipal tax rates with corporate rates. However, I think certainly in considering anything like this it must be borne in mind that this is artificial, to begin with. We really do not have any idea what, relatively, municipals would sell for as a taxable municipal.

First of all, you would have been rating an entirely new market. I think most experts would be of the opinion that it would be considerably more than comparable in terms of rating, so I think what we are really talking about is substantially more than 30 or 40 percent to issue a taxable municipal security.

Mr. GOLDSTEIN. Senator Jordan, to elaborate on what I said a few minutes ago, in the State of Maryland we have a much better rating than our counties and our municipalities so the State has sold the bonds for the counties, and they, in turn, pay us back under our revenuesharing plan.

We have done the same thing with hospitals. We sold a $50 million bond issue. The hospitals could not borrow money under 6 or 7 percent, and the average bonds we sold for that $50 million issue were around 314, and we lend that money to the hospitals on a 40-percent first mortgage and above the percent of cost, so the cities and counties get their hospital facilities, the State is getting its money, and the State does not have the responsibility of running it. It is a very fine plan and it works.

Mr. GOLDBERG. Senator Jordan, that is a growing thing now. We feel that for the poor, relatively unknown, credit which may have trouble marketing that the State really is the solution, as Comptroller Goldstein has mentioned.

The State of North Carolina is doing it, too, and a bill in New Jersey has been introduced to do so, and I would expect if you hold off of any further Federal interference in this field there will be a growing movement in the States to rescue the little-known credit from that problem.

The

Senator JORDAN. Thank you.

Senator Fannin.

Senator FANNIN. Thank you, Mr. Chairman.

May I commend you, gentlemen? I am certainly in agreement with of the philosophy that you have expressed of the independence of the local municipalities and the States, and I think you feel, from what I have heard, that if there is any change made that would place any tax whatsoever on bonds that the constitutionality then would be jeopardized, so I understand the gentleman from South Carolina to say, and this would be a serious question where a contingency would arise any time consideration was made if there was funding for bonds? Is that your position?

Mr. BUCKSON. That is the position, sir, of the National Association of Attorneys General, of which I am a former president, and I appear today on its behalf.

Senator FANNIN. I am sorry. I did not have the benefit of being here, but I have read some of the testimony which is being presented this morning, and I assumed was presented, and I am wondering, I do not know whether this question was asked, it probably was, but how does the allocation of deductions affect the ability of a municipality to finance its capital needs or its interest rates on financing?

The reason I ask that question is through reading some of the testimony I understand you have had a witness here this morning who testified that these factors would not be affected by the proposed legislation, and you have also had witnesses who say that the municipalities would be significantly affected. I wonder what is your view? Mr. GOLDSTEIN. I think Dan Goldberg ought to answer that question. Mr. GOLDBERG. Senator, I think I speak for the other members of our panel. I do not know about Mr. Johnson. We have a feeling that if you accept either of the House proposals, and that would be the allocation of deductions as well, that you will start the market down the path that Mr. Herbert has described. You may pull the plug in the bathtub and the water is going to run out. You can tell the water not to run out, but it is going to run out.

The Treasury put a $45 million revenue yield price tag on that part of the proposal, and we just do not see how the kind of market reaction that these charts show which will lead up to over $1 billion a year in State and local government costs, when we have as many new bonds out that we have paid extra interest on as we now have, that is the $130 billion. One percent of that, which is our judgment, will give you $1.3 billion a year from then on. Now, you cannot explain $1.3 billion of added interest costs in terms of a $35 million plan LTP or a $45 million plan which is the allocation of deductions or the combination of $80 million. It is much more serious than that to the investor.

So we think that the allocation plan would do practically as much damage as the combined plan would do.

Senator FANNIN. I do not know whether you heard the controversial testimony this morning, and I am sorry that I did not have a chance to be here to ask questions of the person who testified on that basis. I did not read his testimony.

Mr. GOLDBERG. I did not hear any controversy this morning, Senator. Senator FANNIN. Of course, I do not know, I was not here, but I do not want to be repetitious.

I certainly appreciate this chance, at least, of asking a couple of questions, and, as I say, I thank you for your position you take. I think it is very realistic.

Mr. GOLDBERG. Could I add just one point there? In talking of that Treasury estimate of what yields, of what they are losing by not taxing our bonds, I have found them most unrealistic because they have always assumed that the present holders or people in the present brackets of those holders would continue to hold them.

Our judgment is that, if the exemption ever went, there would be a massive reshuffling of who the holders would be. I have seen testimony, I think the Investment Bankers put it in the Ways and Means Committee, that if you look at the composition of the holdings of corporate bonds and foreign bonds, which are the principal taxable bonds now on the market, you find half of them are held by people who do not pay any taxes, the foundations and the pension funds and the rest of them, and they averaged up what the yield would be on all taxable, what is now on all taxable bonds, and came up with something like a 15 percent net collection of interest that is paid on those bonds.

I think that is more likely what the Treasury could yield if total exemptions were eliminated than the 42 percent that we have heard. Senator FANNIN. Thank you.

Mr. PATTERSON. Senator, if I may respond to that question, simply stated you have two types of bonds, you have taxable bonds and taxexempt bonds, and if you can remove the exemption, no matter how small it may be, and if you can tax the interest on any bonds held by any investor throughout the length and breadth of this Nation, then you destroy the tax-exempt status of these bonds and when you do that these bonds are going to sell as taxable bonds, there is no getting around that point.

Senator FANNIN. I understand. Thank you very much.

Mr. GOLDSTEIN. On behalf of the panel, sir, we say thank you for your courtesy.

Senator JORDAN. Thank you for your testimony.

Mr. Northcutt Ely.

Gentlemen, you have been very patient. We appreciate your sitting through the long morning waiting your turn, and I would ask you to go ahead at your own speed and convenience and present your testimony. STATEMENT OF NORTHCUTT ELY, GENERAL COUNSEL, AMERICAN PUBLIC POWER ASSOCIATION; ACCOMPANIED BY LARRY HOBART, ASSISTANT GENERAL MANAGER; RICHARD WILSON, CHAIRMAN, COMMITTEE ON TAXATION; AND DON ALLEN, ATTORNEY

Mr. ELY. Thank you, Mr. Chairman.

My name is Northcutt Ely. I am a partner in the law firm of Ely & Duncan of Washington, D.C., general counsel for the American Pub

lic Power Association.

This association speaks for about 1,400 local publicly owned power systems in the 47 States and two territories.

I am accompanied by Mr. Larry Hobart on my right, assistant gen

eral manager of the association; Mr. Richard D. Wilson, chairman of its committee on taxation, and my associate, Mr. Don Allen.

This bill would create, indeed is now creating, a crisis in intergovernmental relations. This, more than the Federal tax revenue involved, and even more than the demoralization of the municipal bond market, is the true significance of this bill. I shall speak also of the liability that the bill would impose upon the Federal Government to substitute its support of essential public local activities now locally supported.

The demoralization of municipal credit can be very readily documented in a way that I have not heard here otherwise.

February 5, 1969, is the day on which the House Ways and Means Committee published the Johnson administration's proposal to tax municipal bonds. We can identify this, perhaps, as Black Wednesday for the municipal bond market.

If 2 days before that date, February 3, a bank and I use the word "bank" deliberately and not individual-had bought $1 million worth of the high-grade State and local bonds which compose the Weekly Bond Buyers' municipal bond average, this portfolio would have shrunk in market value to $835,200 on September 4, 1969, the date that Secretary Kennedy testified before you. This was a loss of 161⁄2 percent.

If you picked an earlier date you would have a larger loss, an earlier date of purchase.

The yield on these top-grade municipal bonds had to rise between these two dates of February 3, 1969, and September 4 from 4.91 percent to 6.37 percent, some 146 basis points, to make such issues or new issues like them salable.

By contrast, if the same bank on the same day had bought $1 million worth of high-grade corporate bonds, composing Moody's corporate bond average, that portfolio on September 4 would have dropped in value to $941,000, a loss of only 6 percent.

The yield on corporates had to rise between these two dates from 6.87 percent to 7.44 percent. That is only 57 basis points to make it possible to market corporate bonds of like quality.

The point is simply this: The cost of bond money to municipalities has risen 211⁄2 times as much or 146 basis points as the cost of bond money to corporations-57 basis points during, and only because of, Congress consideration of proposals to tax municipal bonds.

Such are the consequences of this bill with respect to municipal bonds held by a bank or other corporate holder, even though the bill purports to tax only the interest paid to individuals, and even though individuals have been buying not over 10 percent of new issues in the last 2 or 3 years.

The market has recognized that, if this bill becomes law, no buyer of the municipal bonds hereafter, whether bank, corporation, or individual, will be purchasing a stable contract. If the value of the individual's contract can be impaired retroactively, as this bill does, then, so can a bank's contract with the same issuer in some future bill.

Every buyer, whether individual or corporate, consequently capitalizes the expected tax and adds its consequences to the yield that he demands. The helpless municipality pays the price.

The price reckoned over the life of a bond issue is staggering. State

and local governments in 1968 issued just over $16 billion in bonds, tax exempt under the then-existing Federal statutes.

It has been conservatively estimated in the figures submitted here by the Governors that the debt service that the municipalities would have had to pay if this bill had been law at that time would have been increased by more than $223 million annually or by more than $4.4 billion during the life of a 20-year bond.

These are the consequences with respect to the municipal bond offerings of a single year. But municipalities must issue increasingly greater amounts of bonds each year to provide essential services for an expanding population.

Consequently, the total impact is not $4.4 billion but is that large quantity multiplied by whatever number of years you choose to take as those in which this bill would be operative as it is now tendered to you.

By contrast, the Ways and Means Committee estimated that the Treasury would collect added revenues of only $40 million in 1970, and $85 million a year ultimately from all five of the limitations on tax preferences lumped together, with no value at all assigned to the limitation on municipal bond interest. This is burning down the house to kill the cockroaches.

Moreover, it is no longer asserted by the proponents of this bill that tax-exempt interest shelters a single one of the 154 wealthy nontaxpayers who are highly publicized targets of these five limitations on tax preferences. It is almost certain that the wrong house is being burned down.

High interest costs inflated by the loss of the tax exemption result in the inflation of the costs of essential public services not for 1 year or 2, but for the whole life of the bond issue.

The ultimate burden for that protracted period of time is borne by increases in ad valorem taxes and, therefore, in rents or in increases in the cost of public services which the citizen has no option to forgo.

A 2-percent rise in interest rates from 6 to 8 percent, for example, may necessitate a rise of 20 percent or more in rates for water, power, sewerage, and other essential services. This is because these public works are essentially highly capital intensive. A great deal of moneyborrowed money-must be invested for each dollar of revenue produced.

Consequently, an increase in the cost of money has a leverage effect upon the rates and charges which must be collected in order to service that inflated debt.

The inflation of the cost of living compelled by the bill will fall most heavily on those of our citizens who are least able to bear it-those to whom the bills for rent, electricity, and water are serious problems.

A Federal tax which directly increases the cost to the States and their political subdivisions of borrowing money, imposing a burden on the borrowing power at the moment of its exercise, "is a tax on the power of the States, and on other instrumentalities to borrow money, and consequently repugnant to the Constitution."

I am quoting from Pollock v. Farmers' Loan and Trust Company, affirmed on rehearing, 158 U.S. 601 (1895), and the argument is spelled out in the brief which is annexed to my prepared statement.

So tested, both the limitation on tax preferences and the allocation