AARP Hearing Center
Background
State and local governments issue bonds to finance important projects that meet social goals and benefit communities. Bonds are attractive because they provide financial flexibility. They offer governments the option of financing a project over a period of years. This avoids the need for a large, upfront lump sum of money from the general fund. In addition, the tax-exempt status of bonds allows state and local governments to borrow at preferred interest rates.
At the same time, bonds are inherently risky. Borrowing jurisdictions must repay investors with interest. Bond payments take precedence over other expenses of state and local governments. Borrowing jurisdictions must maintain taxes over the bond's lifetime at a level sufficient to make the payments.
State and local bonds are classified as either government or private activity bonds (PABs). There are no restrictions on the types of projects for which government bonds can be issued. However, for PABs to be tax-exempt, they can only be issued for qualified purposes. These are defined in the federal tax code and include airports, sewage facilities, and multifamily rental housing. In addition, certain PABs are subject to an annual state volume cap. This limits the amount that can be used.
Tribal governments face more stringent restrictions on the use of tax-exempt bonds than state and local governments. They are only permitted to issue government bonds for what are considered “essential government functions.” The tax code defines these as functions that are customarily performed by state and local governments. However, there is a lack of clarity as to what type of projects meet this definition. In addition, tribal governments are prohibited from issuing any private activity bonds, except for the construction of certain manufacturing facilities that meet complex and restrictive employment requirements. As a result, tax-exempt bond financing, which is a valuable tool for building economic infrastructure, is rarely used by tribal governments.
ISSUANCE OF BONDS: Policy
ISSUANCE OF BONDS: Policy
Bond financing criteria
When considering bond financing, state and local policymakers should:
- ensure that repaying the bond will not cause a financial strain on the state or local government budget;
- consider who will benefit from the project, including older residents, those with lower incomes, and multicultural communities;
- evaluate whether the intended social goal is worth the potential for higher tax burdens on certain citizens or in certain communities;
- ensure that a sufficient revenue stream supports the bond payments; and
- ensure that the bonds can secure a credit rating that suggests the issuer will be able to pay it back on time and in full.
Tax increment financing (TIF)
TIF projects should only be used when evidence shows that:
- the private sector is unlikely to invest in the designated area without government investment,
- the project's failure would not put at risk the locality's ability to provide critical government services, and
- current residents will benefit from the investment over the long term.
Policymakers and researchers should track, study, and report on TIF projects. TIF projects that use bonds should comply with a bond financing criteria policy.
Tax-exempt bond financing
Tribal governments should be able to issue tax-exempt government and private activity bonds for the same types of projects allowed for state and local governments.
Flexibility in project type: The essential government function standard should be repealed for tribal governmental tax-exempt bond financing. In addition, tribal governments should be able to use bonds to finance projects located on reservations as well as those that are located on land contiguous or connected to a reservation and provide goods or services to its residents.
Bond caps: Any private activity bond volume cap for tribal governments should be comparable with the state private activity bond volume cap. The cap also should consider the diverse characteristics of tribal governments.