Farm, Nutrition, and Bioenergy Act of 2007

Floor Speech

FARM, NUTRITION, AND BIOENERGY ACT OF 2007 -- (Senate - December 14, 2007)

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Mr. GRASSLEY. Mr. President, the managers' amendment to the farm bill contains a deal that raises my eyebrows. The proposal creates a half billion dollars in strippable, tradable, ``forestry tax-credit bonds'' that can be issued by a State or tax-exempt entity. Property must be approved by the U.S. Fish and Wildlife Service as subject to a ``native fish habitat conservation plan.'' So far, we can only find one plan that qualifies for this proposal. The proposal also completely unwinds the arbitrage rules that were placed on these tax-credit bonds last year to prevent abuses.

Most Americans do not know what tax-credit bonds are or even that they exist. Essentially, these are bonds in which the federal government pays ``interest'' in the form of credits against Federal income tax liability. Issuers borrow at a zero percent interest rate. The Federal tax subsidy provided to the holder of a tax credit bond is even greater than the benefit derived from tax-exempt municipal bonds. That is because a tax credit can be used to offset, on a dollar-for-dollar basis, a holder's current year tax liability. With tax credit bonds, the Federal Government bears virtually all of the cost of borrowing--in the form of forgone revenue--even if the bonds are issued by a non-Federal entity such as a State or local government. So, in short, this is a rich deal.

When the tax credit bond program was initiated, the arbitrage rules did not apply. However, we became aware of arbitrage abuses in 2006. In response, Congress enacted arbitrage restrictions for these bonds. They are the same restrictions that already apply to tax-exempt municipal bonds. The Tax Reform Act of 1969 enacted the first rules relating to arbitrage. Congress was concerned that permitting interest exemption for arbitrage bonds represented a waste of the Federal subsidy.

One of the concerns Congress addressed was the use of sinking funds to exploit the difference between tax-exempt and taxable rates. The best way to understand these rules is to use an example. Let's assume City X needs to borrow $10,000 to finance a project. City X could issue bonds that pay no principal or interest until year 10 and fund its year 10 liability by depositing amounts into a special fund--a ``sinking fund''--that will build up over time and be used to pay off the interest and principal in the 10th year.

In the absence of arbitrage restrictions, City X can invest amounts in the sinking fund over the term of the bonds at a higher yield than the yield on the bonds--remember that tax-exempt bonds accrue interest at zero percent. This would allow City X to earn more than is needed to pay both the principal and interest on the bonds at maturity. This is a subsidy funded by the Federal government and paid for by tax increases on Americans.

The tax credit bond program already provides a richer subsidy than the long standing tax exempt bond program. This proposal further enriches this program, at the expense of taxpayers, and opens the door for future abuse. This provision may set a dangerous precedent and unwind all of the good work that was done to ensure that arbitrage abuses of tax credit bonds were curtailed.

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