The National Governors' Conference in 1968 stated that "the reciprocal freedom of the states and the Federal government from taxation from each other is essential to the survival of our Federal system of dual Federal-State authority." The Conference went on to declare that "this freedom necessarily encompasses the immunity of State and local government obligations from Federal taxation." This statement was based on a long history of Supreme Court decisions and a realization that any Federal mechanism that tampered with the tax-exempt status of State and local bonds, whether it be subsidies, guarantees, or taxation on interest, would weaken our Federal system and perhaps violate the Constitution interest, would weaken our Federal system and perhaps violate the Constitution.

It is also important to realize that this provision will produce inequities for those whom the Tax Reform Act is designed to help. The impact of this proposed legislation has already had a damaging effect on the market for all local government securities. Prices have dropped and interest rates have increased. The State of Ohio, for example, recently was forced to market its bonds at 5.94 percent. If these securities had been sold prior to the proposal of the legislation, it is estimated that the taxpayers of Ohio would have been saved approximately $1 million in interest over the time the bonds will be outstanding. This is one example of one small issue in one State. Nationally, the passage of this provision could result in the almost total collapse of the municipal bond market. Locally, the slack will have to be taken up by the average tax-paying citizen.

State and local governments have often been criticized for their lack of a stable tax base. We have been called regressive because we have had to rely principally on property and sales taxes. On top of these, several localities have enacted so-called nuisance taxes, such as occupational privilege and head taxes. We are, however, taking steps to establish a more stable and equitable tax base. If the tax exempt status of bonds is changed and the market for these securities disappears, any steps that we may take to alleviate regressive taxes and to eliminate nuisance taxes will be thwarted. Another source of financing will be needed at State and local levels. What I am saying is that the effect of this provision on State and local government will be regressive. Ultimately, the individual taxpayer will have to pick up the tab, and not necessarily our wealthier citizens.

It should also be noted that our wealthier citizens are not escaping most of their Federal taxes by investing in State and local bonds. The fact is that these bonds constitute ten percent or less of the holdings of millionaires as a class. Banks, insurance companies, and other institutions, which do not pay a graduated income tax at all, hold twice as many of these bonds than do individuals.

We must also bear in mind that those individuals who hold the minor proportion of available municipal securities do so at a price. They could invest in comon stocks and other issues which provide a greater hedge against inflation and have the possibility of higher yields. They do invest in municipals because they believe that the lower interest rates which they accept are offset by the tax benefits which accrue to these securities. In effect, they find a small but important advantage in helping to underwrite the costs of government and the economic development of our communities.

This partnership between public leadership and private enterprise must be encouraged and strengthened. We at State and local levels have difficulty financ ing our present needs without any new burdens by loss of tax exemption. Some have described our present predicament as a fiscal crisis. If local securities are attractive because buyers obtain a net advantage, we must realize that the price is worth it. If some interpret this arrangement as a subsidy, let us regard it as a subsidy to State and local government, and not as a tax shelter for a few individuals.

In conclusion, let me reiterate that my opposition to modifications in the taxexempt status of State and local bonds is based not on a desire to perpetuate the status quo, but on the belief that it will not achieve its purpose. If we are striving to provide tax equity for all our citizens, as we must, then we must preserve the ability of State and local governments to finance much needed public projects from other than regressive and nuisance-type taxes.

I oppose this provision because I feel it could damage our system of Federalism and possibly violate the Constitution.

I oppose it because I believe that solutions to many of the problems which face us can better be found at the State and local level, and not at the Federal

level. The formulation of these solutions requires imagination, initiative, and financial resources. There is, perhaps, too little of all these to do the job that must be done. However, we are making progress and anything that impedes our progress, such as this provision of the Tax Reform Act, must be labeled as suchand defeated.

It is my hope that these remarks will assist you in making your judgments. I recognize the importance, and the difficulty, of your task in devising tax reform proposals, and I think you for allowing me to submit my views on this subject. Sincerely yours, RAYMOND P. SHAFER, Governor.

STATEMENT OF HON. PRESTON SMITH, GOVERNOR OF TEXAS

The objectives of those provisions of H.R. 13270 which treat with bonds of state and local government can be more accurately described as spiteful and coercive than as reformatory.

Spite is obviously directed towards a handful of investors who, in lending money to state and local government at a much lower rate of return than could have been realized elsewhere, have minimized their Federal income tax liability and stand accused of taking advantage of a loophole.

Coercion is aimed at states and their political subdivisions in what amounts to a surtax on their borrowing to the end that they will be driven into involuntary dependence upon the monster of bureaucracy.

It is patently clear that the architects of this plan had in mind Sections 301 and 302 as agents of destruction-destruction of the market for state and local government bonds-while Sections 601 and 602 were designed to provide an agent of rescue: the Federal bureaucracy as the sole remaining source of capital funds for state and local government. If H.R. 13270 is enacted into law in the form passed by the House of Representatives, I say that eminent but deplorable success will be attained by those who conceived this scheme. Centralism will have at long last prevailed over local home rule.

An emergency exists in my State of Texas today-an emergency brought on entirely by the passage in the House of Representatives of H.R. 13270. The only remedy is the deletion of those four sections from the bill. Even then recovery will be slow. We shall bear the scars for months and years to come.

Texas is endowed with a combination of rich natural resources and an energetic and resourceful citizenry, which has resulted in a rate of economic development somewhat above the national average. For this we are grateful, although it produces an ever growing problem for those who are charged with providing capital funds for the myriad public works and facilities demanded by an expanding population and a standard of living whose course is progressively upward.

In the year 1968 the agencies of state government, our state supported institutions of higher learning, and our local governmental units issued bonds in the aggregate of almost $1 billion. Still we lost ground in the race to meet our needs for expanded educational plants, water resources development, water pollution control, hospital facilities, airport construction, roads and streets, and all of the other purposes for which state and local bonds are issued. (With only about 5% of the nation's total population, we do, year after year, account for 7% to 8% of the annual volume of long term financing by state and local governments in the United States.)

The march of inflation together with a general tightening of credit had steadily pushed the cost of borrowing for capital improvements upward; then came Viet Nam, and we truly began to learn the meaning of high interest costs on borrowed capital. Money for schoolhouses which formerly cost 3% had moved up to 52% and 6%. Hospitals, built during the earlier part of this decade at reasonable interest costs, were being financed at interest rates which had more than doubled. All but the larger cities, the counties with major population centers, and the school districts with unusually large tax bases, found themselves in a position of being unable to sell bonds-because of restraints in our statutes on maximum interest rates which could be paid legally.

In my message to the 61st Texas Legislature which convened in Regular Session in January, 1969, I submitted one, and only one, emergency recommendation corrective legislation to increase the maximum legal interest rate on all

bonds, where governed by statute, to 6%. The Legislature responded quickly. We soon had a statute on the books which permitted local governmental unit to proceed with the financing of their badly needed construction programs.

But the efficacy of this remedy was short lived. Within six months there were delegations representing some of the largest municipally-financed projects in our State calling at my office imploring me to submit to a called session of the Legislature, then in session, additional legislation designed, this time, not to increase interest rate limitations again, but to remove them entirely.

Our prolonged economic boom has produced an inflation of all costs, including the cost of borrowing money, and the strain on our economy resulting from the Viet Nam conflict has exacted its toll. These things, though, we could have coped with. We tightened our belts, and we tackled the necessary-if unpleasant-chores of increasing assessment ratios of taxable property, of in creasing tax rates, and of boosting user charges for those projects financed with revenue bonds.

We could have met the crisis, and we could have survived except for one thing: so-called tax reform measures under consideration by the House Ways and Means Committee. The bad publicity, the misleading propaganda, and the half-truths which have come out of these machinations (there were no hear ings), have virtually destroyed the market for bonds of state and local governments.

The only course left open to us was to remove all limits on local governmental bond interest rate, and this we have now done in Texas. The municipal bond market has become so utterly shattered, and the morale of investors so under mined by actions of the Federal government, that state and local government must now compete with private industry for capital. There are worthy projects in Texas which must be financed regardless of borrowing costs; hence the removal of limitations on interest rate.

But this is not the answer. There remain those public facilities which can be financed only through a pledge of user charges, and which become economically infeasible when the sponsoring governmental agency is obliged to pay 7%. 8% of more in annual interest rates. Consider also the plight of units of local govern ment with a rigidly limited debt service budget. To illustrate: a small school district which needs a $1 million school building can finance it with a debt service budget of $66,050 per year if it can sell 30-year bonds at an interest rate of 5%. The total final interest cost is $981,500.

Increase the interest rate to 6%, and that same $66,050 debt service budget requires an amortization period of 45 years on a $1 million bond issue and an ultimate interest cost of $1.972,250. But what happens when the bond market reaches such a chaotic state that an interest rate of 7% is required to make the bonds on our hypothetical district saleable? Interest alone on a $1 million school bond issue is $70,000 per year. Of what help to this district is a statute which removes the legal limit on interest rate?

The securities industry in this country is in the hands of some of the most astute persons within the business community, and the same is generally true of those who invest in state and local government bonds. The industry and the community which it serves has kept an apprehensive eye on the Washington scene for several years, particularly since the Supreme Court's ruling in the Atlas Life Insurance Company case in which the Court, in interpreting the Life Insurance Company Income Tax Act of 1959, denied the right of full exemption on interest income from municipal bonds held by a life insurance company. Within a span of about six years the percentage of investments of all life insurance companies represented by state and local government bonds has shrunk from more than 6% to less than 1%.

Apprehension grew into alarm as the tax-exempt bond sector of the securities market saw the handwriting on the wall with such unfortunate happenings as the testimony given to the House Ways and Means Committee in November, 1968 concerning 154 individuals in the country who, despite annual incomes in excess of $200,000, paid no Federal income taxes; the impression was allowed to spread abroad that this was accomplished with interest income on tax-exempt municipal bonds. No publicity at all was given to later testimony before the same committee showing that there was not a single person out of these same 154 who used municipal bond interest as the principal tax reducing factor.

The market for state and local government bonds has been, for all practical purposes, destroyed. We in Texas are confronted with such problems as the plight of America's sixth largest city, Houston, which, in an attempt to secure $24 million

n capital funds for emergency enlargements and extensions to its waterworks system, was unsuccessful in receiving a single bid for its bonds notwithstanding permissible interest rate of 6%. For all of this we can thank the House of Representatives for its passage of H.R. 13270 and its inclusion of Sections 301 and 302.

Proponents of the measure point, of course, to other provisions of the bill, the rescue device, the free money subsidy afforded by Sections 601 and 602. In view of the enormity of the problem, the extent of the emergency, it would appear at first blush that there is really no other alternative but to walk into this trap which the architects of the scheme have provided.

Even if we were willing to go to this extreme to meet the real emergency which exists, and even if we were willing to transfer the whole local decision making process to the Washington bureaucracy, would it work? The answer is no. We have not yet really seen any chaos in the area of state and local government capital financing until an attempt is made to set that scheme in motion. Myriads of legal questions immediately present themselves, as well as some very practical ones such as enabling legislation in each of the fifty states, et cetera. A snarl of gargantuan proportions will be the inevitable result; a paralysis in the market where the private sector is afraid to proceed and where the bureaucracy is enjoined from operating is bound to occur. This must not be allowed to happen.

Aside from the inconvenience and the actual endangering of human life and property resulting from a shutdown-or even a major slowdown-in the construction of public works and improvements financed with state and local government bonds, there is to be considered the cost, the economic loss, direct and indirect.

This threat to the tax-exempt status of state and local government bonds has been in the making for at least a year. In my state we have issued bonds during that year to the extent of about $1 billion. The most conservative estimate I have had from reliable sources is that the additional interest rate resulting from this disturbing factor in the bond market is at least 1%; and most estimates are higher. But with the addition of only 1%, the proponents of this measure have already cost the State of Texas and its political subdivisions not less than $150 million in ultimate interest charges. The corresponding figure for the country as a whole would be about $2.4 billion, and please bear in mind that this is just one year's borrowing.

Not only is the self-reliance of local governments in meeting their own needs at stake, but also confidence in governments . . . the credibility of governments which already have sold tax-exempt bonds.

I urge the Committee to delete Sections 301, 302, 601, and 602 of the bill. PRESTON SMITH, Governor of Texas.

SENATE OF PENNSYLVANIA, Harrisburg, September 25, 1969.

Hon. RUSSELL B. LONG,
Senate Office Building,

Washington, D.C.

MY DEAR SENATOR LONG: I wish to protest the changing of the tax-exempt status of State and municipal bonds, as proposed by the Congress of the United States.

Yesterday, the Pennsylvania Senate Banking Committee had a meeting with respect to raising interest rates on State municipal bonds. We had present three nationally known representatives of the banking profession. We are absolutely amazed to hear the chaos facing State and municipal bonds, due to the move by certain people in the Congress to make such bonds taxable for income tax purposes.

If these bonds are made taxable, there will be a partial collapse in the construction of highways, hospitals, schools, public housing and other public construction. Sewers so necessary for clean streams can be forgotten.

The Congress of the United States has already done great damage to the interest rates of State and municipal bonds. The bankers are demanding more interest because there is now a calculated risk of Federal taxability. This is a vicious situation that can benefit no one.

Very sincerely yours,

CLARENCE D. BELL, Senator.

Mr. TOM VAIL,

SEPTEMBER 18, 1969.

Chief Counsel, Senate Finance Committee,

New Senate Office Building, Washington, D.C.

DEAR MR. VAIL: As Mayor of the City of Providence, I am deeply concerned with the effects of the proposed tax on the interest received from holders municipal bonds. I had our finance department do a preliminary study of th impact such a tax would have upon the tax rate in the City of Providence. C the basis of this study the following conclusions were arrived at:

The City of Providence currently has authorized but not yet bonded 80 millio dollars in new issues.

On the basis of projection of these figures over the next five year period end ing in 1975, the tax rate increase to the Providence tax payer resulting solely from the effect of the tax on interest from municipal bonds would be approx mately $.63 the first year, $1.86 the second year, $3.02 the third year, $4.11 the fourth year, $5.15 the fifth year and $6.00 by the end of the fifth year.

These figures were derived at simply by considering the 80 million dollars already authorized and not yet issued. This does not take into consideration any new future issues. We allowed merely for the differential in the interest pay ments which would have to be made up to holders of these bonds. Therefore, by using an interest rate of 10% rather than the present 5% return, the net result would be to raise the tax rate in the City of Providence by the amounts listed above. Such a tax increase to the residents of the City of Providence would come at a most inopportune time when additional and increasing demands are being made by the teachers, police and fire and the municipal employees; and the costs of municipal services as a whole are increasing. Since most cities are experienc ing the same demands for increased services at higher costs, the added burden of additional interest payments to holders of municipal bonds would cause our local tax rates to sky rocket. This in turn would most likely affect the low in come and middle income tax payer. Also, the City would have to turn more and more to the federal government for alternative means of financing which would mean shifting more local control to the federal level.

I urge you to carefully consider the potentially dire effects such a tax would have on local governments before approval is given. Very truly yours,

Senator RUSSELL B. LONG,

Chairman, Senate Finance Committee,

JOSEPH A. DOORLEY, Jr.,

Mayor of Providence.

CITY OF GRAND ISLAND,

Grand Island, Nebr., September 30, 1969.

New Senate Office Building, Washington, D.CO.

DEAR SENATOR LONG: The City of Grand Island, Nebraska, objects to these three specific provisions in H.R. 13270:

1. To include the interest from municipal bonds in an allocation of deductions rule.

2. To include interest from municipal bonds in a limit on tax preference. 3. To establish a bond interest subsidy program for bond issuers who waive their tax exemption.

The passage of this bill by the House has already demoralized the present holders of and the prospective purchasers of municipal bonds.

We have some $20,000,000 plus of bonded indebtedness at the present time Most of this was issued for water and electric operations. Ironically, our citizens voted approval for $1,425,000 bond issue this Spring. This was the first bond issue approved for municipal purposes since 1938, in our City: This issue is the City's share of matching funds for a HUD grant for a storm sewer project. Storm sewer proposals have been defeated three times prior to this election. Now we cannot sell our bonds because of a maximum state interest ceiling and HR 13270. The first reason will be rectified in late December, when the new legis lation removing the ceiling, becomes effective. You hold the reins on the latter. The Senate Finance Committee should, in our opinion, take a stand to oppose the retention of the above three provisions immediately. This would help to sta bilize the municipal bond market and reduce interest rates again to make them saleable. Please request this of your committee.

We respectfully urge that no change be effected in the present tax exempt bond law for governmental issues.

Sincerely yours,

JOHN DITTER, Mayor.

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