School Modernization Bonds
H.R. 4094, the Johnson-Rangel compromise, helps communities leverage more dollars for school construction or renovation by:
- Providing federal income tax credits to bondholders in lieu of interest payments made by communities; and
- Ensuring that communities use any earnings on temporary investment of unexpended bond proceeds for school construction or renovation.
H.R. 7, the House Ways and Means proposal, expands two exceptions to the general tax rule that arbitrage earnings on the proceeds of tax-exempt bonds be rebated to the federal government. (Arbitrage is the practice of delaying construction and investing the funds raised from bonds to earn more interest than they are paying on the bond.)
- Extending the period during which arbitrage earnings may be retained (and used for school construction purposes) from two years to four years for school construction bonds; and
- Expanding the additional amount of school construction bonds on which small issuers may retain arbitrage (used for any governmental purpose) from $5 million to $10 million. The benefits of the proposal depend upon stretching out the time between the issuance of school bond and the use of the proceeds for construction or renovation.
The amount of additional funds for school modernization made available by the two proposals was calculated in a two-step process. First, since both proposals would assist communities in the issuance of school bonds, the value to the community of each proposal was calculated per $1000 bond [ 1 ]. Because the two proposals would deliver their respective benefits over different periods of time, the benefit figures were then discounted to present value [ 2 ]. The benefit figures per $1000 bond calculated in this manner are $624.77 for H.R. 4094, the Johnson-Rangel compromise, $8.62 for H.R. 7, the Ways and Means proposal, to extend the period of the current general exemption from arbitrage rebate for construction bonds, and $13.93 for their proposal to expand the small-issuer exemption from the arbitrage rebate requirement in the tax code.
Second, the two proposals would also apply to different potential volumes of school bonds. Therefore, the benefit numbers per $1000 bond were then multiplied by the estimated maximum number of bonds to which the proposals could be applicable, with no increase in debt service costs to local communities over 1998 levels [ 3 ]. The resulting numbers for the H.R. 7 provisions were then combined. The total benefit numbers calculated in this manner are $15.5 billion for H.R. 4094, the Johnson-Rangel compromise, and $1.7 billion for H.R. 7.
- The debt-service reductions on a $1000 15-year 5-percent tax-credit bond from the no-interest aspect of H.R. 4094, the Johnson-Rangel compromise, were calculated by subtracting level annual payments of $42.96 into a sinking fund earning 6 percent from level annual payments of $65.05 on a $1000 30-year 5-percent tax-exempt bond. The present value of the savings is $555.13. The temporary-investment earnings on unexpended bond proceeds were calculated at an assumed rate of 5 percent on an average construction fund balance over three years of $500 per $1000 bond. The present value of these earnings is $69.94. The additional arbitrage income from the Ways and Means proposal has been calculated on an assumed 1-percentage-point spread between the earnings rate and the interest rate on the bonds on an average construction fund balance over four years (three with respect to small-issuer bonds) of $500 per $1000 bond.
- All present values were calculated using a tax-exempt rate of 5 percent.
- Because H.R. 4094, the Johnson-Rangel compromise, is for $24.8 billion of new tax-credit bonds, the present value per $1000 was multiplied by 24.8 million. Because the Ways and Means proposal to liberalize the arbitrage rules for tax-exempt school bonds would theoretically apply to all new bonds, the present value of additional arbitrage earnings per $1000 bond was multiplied by 10 years of issuance at an assumed annual rate equal to the 1998 actual rate of $23.4 billion. For this purpose, it was assumed that half of the estimated 1998 volume of $3.7 billion entitled to the expansion of the small-issuer exemption would take advantage of it, and the other half would utilize the proposed 2-year extension of the time period for retaining arbitrage earnings.
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