Order Code RL31457
CRS Report for Congress
Received through the CRS Web
Private Activity Bonds: An Introduction
Updated June 9, 2006
Steven Maguire
Economist
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

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Private Activity Bonds: An Introduction
Summary
The federal tax code classifies state and local bonds as either governmental
bonds or private activity bonds. Governmental bonds are for projects that benefit the
general public, and private activity bonds are for projects that primarily benefit
private entities.
The federal tax code allows state and local governments to use tax-exempt
bonds to finance certain projects that would be considered private activities. The
private activities that can be financed with tax-exempt bonds are called “qualified
private activities.” Congress uses an annual state volume cap to limit the amount of
tax-exempt bond financing generally and restricts the types of qualified private
activities that would qualify for tax-exempt financing to selected projects defined in
the tax code.
Although this report does not include a comprehensive economic analysis of
tax-exempt private activity bonds, it does provide some background on the reasons
for the federal limitation on tax-exempt bonds for private activities. In addition, this
report explains the rules governing qualified private activity bonds, describes the
federal limitations on private activity bonds, lists the qualified private activities, and
reports each state’s private activity bond volume cap.
Since private activity bonds were defined in 1968, the number of eligible private
activities has been gradually increased from 12 activities to 21. The state volume
capacity limit has increased from $150 million and $50 per capita in 1986 to the
greater of $246.6 million or $80 per capita in 2006. Because of the $246.6 million
floor, most small states are allowed to issue relatively more private activity bonds
(based on the level of state personal income) than larger states. Also, more recent
additions to the list of qualified activities have been exempt from a state-by-state cap
and subject to a national aggregate cap.
In the 109th Congress, the “Gulf Opportunity Zone Act of 2005” (GOZA 2005,
P.L. 109-135) included several modifications to private activity bond rules that are
intended to help rebuild the Gulf Coast region after the 2005 hurricanes. In
particular, under provisions in the GOZA 2005, the states of Alabama, Louisiana, and
Mississippi are allocated additional private activity bond volume though January 1,
2011, granted relaxed eligibility rules for mortgage revenue bonds, and afforded the
opportunity to advance refund outstanding tax-exempt bond debt.
For more on tax-exempt bonds generally, see CRS Report RL30638, Tax
Exempt Bonds: A Description of State and Local Government Debts, by Steven
Maguire. This report will be updated as legislative events warrant.

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Contents
Overview and Issues for Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Issues for Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Fundamentals of Private Activity Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Interest Rates on Tax-Exempt vs. Taxable Bonds . . . . . . . . . . . . . . . . 4
Interest Rate Spread . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Tax-Exempt Bonds and the AMT . . . . . . . . . . . . . . . . . . . . . . . . . 5
Technical Definition of Private Activity Bonds . . . . . . . . . . . . . . . . . . 6
What Are the Qualified Private Activities? . . . . . . . . . . . . . . . . . . . . . . 6
The Revenue and Expenditure Control Act of 1968 . . . . . . . . . . . 7
The Tax Reform Act of 1986 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Empowerment Zones and New York Liberty Zones . . . . . . . . . . . 7
Gulf Opportunity Zone Act of 2005 . . . . . . . . . . . . . . . . . . . . . . . 8
IRS Review of Tax-Exempt Status . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
What Is the Private Activity Volume Cap? . . . . . . . . . . . . . . . . . . . . . . 9
Allocation by Type of Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Other Restrictions on Private Activity Bonds . . . . . . . . . . . . . . . . . . . 14
Conclusion and Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
List of Tables
Table 1. Yield on Tax-Exempt and Corporate Bonds of Equivalent Risk,
the Yield Spread, and the Yield Ratio:1980 to 2005 . . . . . . . . . . . . . . . . . . . 5
Table 2. Qualified Private Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Table 3. Annual State Private Activity Bond Volume Cap, 2005 and 2006 . . . . 11
Table 4. Private Activity Bond Volume by Type of Activity in 2003, 2004,
and 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

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Private Activity Bonds: An Introduction
Overview and Issues for Congress
State and local governments issue debt for most large public capital projects
such as new schools, public buildings, and roads. On occasion, state and local
governments will issue debt for projects whose purpose is less public in nature, such
as privately owned and operated multifamily residential housing. Nevertheless, these
projects are often afforded the same tax privilege as debt issued for strictly
government owned and operated projects. Congress limits the use of tax-exempt
bonds for private activities because of concern about the overuse of tax-exempt,
private activity bonds. The tax-exempt bonds issued for qualified private activities
are limited by the type of activity financed and the volume of debt used for such
activities.
Overview. The federal tax code classifies state and local government bonds
as either governmental bonds or private activity bonds. Generally, the interest on
state and local governmental bonds is exempt from taxation whereas the interest on
private activity bonds is not tax-exempt.1 However, the federal tax code allows state
and local governments to use tax-exempt bonds to finance certain projects that would
otherwise be classified as private activities.2 The private activities that can be
financed with tax-exempt bonds are called “qualified private activities.”3
The current tax exemption for qualified private activities has evolved over time.
Two events, however, critically shaped the current treatment of private activity
bonds. First, in 1968, Congress passed the Revenue and Expenditure Control Act of
1968 (P.L. 90-364) which established the basis for the current definition of private
activity bonds. After persistent challenges to the right of the federal government to
restrict state and local government debt following the 1968 Act, the Supreme Court
agreed to hear a case in 1988 that changed the nature of the federal tax treatment of
state and local government debt. In that case, the state of South Carolina challenged
the Tax Equity and Fiscal Responsibility Act of 1982 (P.L. 97-248). The 1982 Act
required that state and local government tax-exempt debt must be registered.4 The
1 The tax-exemption is provided for in 26 U.S.C. 103.
2 The Internal Revenue Service (IRS) uses a two part test to classify an activity as a private
activity. This test will be explained in more detail later in the report. Generally, activities
are classified as “private” because private individuals and businesses benefit directly from
debt issued by the state or local government.
3 26 U.S.C. 141 describes requirements for qualified private activity bonds.
4 Before this act was passed, state and local government usually issued bearer bonds that
paid principal and interest to whomever presented the bond to the issuer (or the issuer’s
(continued...)

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registration requirement was viewed by the states, South Carolina in particular, as an
unconstitutional intrusion on the ability of states to issue debt. The Supreme Court
held that the registration requirement for non-federal government, though federally
tax-exempt, debt was constitutional. In somewhat of a surprise to observers at the
time, the Court went beyond the registration ruling and also held the following:
The owners of state [and local] bonds have no constitutional entitlement not to
pay taxes on income they earn from the bonds, and states have no constitutional
entitlement to issue bonds paying lower interest rates than other issuers.5
The ruling confirmed that Congress can restrict issuance of state and local tax-
exempt debt and could even rescind the tax-exemption altogether.6 Nevertheless,
outright repeal of the tax-exemption is unlikely. Instead, Congress has limited
legislative action to modification of the existing rules and definitions governing tax-
exempt bonds for private activities. Generally, Congress limits the amount of tax-
exempt debt that can be used for private-activities and restricts the type of private
activities that can be financed with tax-exempt bonds. Congress can, and does,
encourage selected private activities by exempting the activity from the volume cap
or by allowing tax-exempt financing for the private activity.
Issues for Congress. As noted above, Congress uses two primary means to
restrain the use state and local debt for private activities: an annual state volume limit
(or separate national aggregate limit) and restrictions on the type of qualified private
activities. The private activity bond volume limit, which originated in the Deficit
Reduction Act of 1984 (P.L. 98-369), was implemented because “Congress was
extremely concerned with the volume of tax-exempt bonds used to finance private
activities.”7 The limit and the list of qualified activities were both modified again
under the Tax Reform Act of 1986 (TRA 1986, P.L. 99-514). At the time of the
TRA 1986 modifications, the Joint Committee on Taxation identified the following
specific concerns about tax-exempt bonds issued for private activities:8
4 (...continued)
agent, usually a bank). In contrast, a registered bond includes the owner’s name on the bond
and a change in ownership must be registered with the issuer (or the issuer’s agent). For a
full discussion of the impact of the South Carolina vs. Baker case on tax-exempt bonds, see
Bruce Davie and Dennis Zimmerman, “Tax-Exempt Bonds After the South Carolina
Decision,” Tax Notes, vol. 39, no. 13, June 27, 1988, p. 1573.
5 State of South Carolina vs. J.A. Baker, Secretary of the Treasury: Supreme Court of the
United States, April 20, 1988. 485 U.S. 505.
6 Ibid.
7 U.S. Congress, Joint Committee on Taxation, General Explanation of the Revenue
Provisions of the Deficit Reduction Act of 1984, 98th Cong., 2nd sess. (Washington: GPO,
1984), p. 930.
8 U.S. Congress, Joint Committee on Taxation, General Explanation of the Tax Reform Act
of 1986, 100th Cong., 1st sess. (Washington: GPO, 1987), p. 1151.

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! the bonds represent “an inefficient allocation of capital”;
! the bonds “increase the cost of financing traditional governmental
activities”;
! the bonds allow “higher-income persons to avoid taxes by means of
tax-exempt investments”; and
! the bonds contribute to “mounting [federal] revenue losses.”
The inefficient allocation of capital arises from the economic fact that additional
investment in tax-favored private activities will necessarily come from investment
in other public projects. For example, if bonds issued for mass commuting facilities
did not receive special tax treatment, the bond funds could be used for other
government projects such as schools or other public infrastructure.
The greater volume of tax-exempt private activity bonds then leads to the
second Joint Committee on Taxation concern, higher cost of financing traditional
government activities. Investors have limited resources, thus, when the supply of
tax-exempt bond investments increases, issuers must raise interest rates to lure them
into investing in existing government activities. In economic terms, issuers raising
interest rates to attract investors is analogous to a retailer lowering prices to attract
customers.
The final two points are less important from an economic efficiency perspective
but do cause some to question the efficacy of using tax-exempt bonds to deliver a
federal subsidy. Tax-exempt interest is worth more to taxpayers in higher brackets,
thus, the tax benefit flows to higher income taxpayers, which leads to a less
progressive income tax regime.
The revenue loss generated by tax-exempt bonds also expands the deficit (or
shrinks the surplus). A persistent budget deficit ultimately leads to generally higher
interest rates as the government competes with private entities for scarce investment
dollars. Higher interest rates further increase the cost of all debt financed state and
local government projects.
Supporters of tax-exempt bonds for private activities counter that the benefit
from tax-exempt bonds exceeds both the explicit (the revenue loss) and implicit (the
inefficient allocation of capital) costs of the tax-exemption.
The debate surrounding use of tax-exempt bonds will continue well beyond the
current Congress. Proponents and opponents of tax-exempt bonds generally, and
private activity bonds specifically, both explore methods of modifying the rules for
private activity bonds to advance their respective positions. Because the rules and
definitions for private activity bonds are complex, uncertainty about the potential
effects of the proposed modifications to those rules is common. This report will not
attempt to either justify or criticize the existence of or use of tax-exempt private
activity bonds.9 Instead, the report provides a brief review of bond fundamentals and
9 For a comprehensive economic assessment of private activity bonds, see Dennis
Zimmerman, The Private Use of Tax-Exempt Bonds: Controlling Public Subsidy of Private
(continued...)

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a more detailed examination of the rules and definitions surrounding private activity
bonds to help clarify the impact of the of those modifications.
Fundamentals of Private Activity Bonds
Interest Rates on Tax-Exempt vs. Taxable Bonds. Tax-exempt bonds
for governmental purposes and for qualified private activities are special because,
unlike corporate bonds or U.S. Treasury bonds, the bond buyer does not have to
include the interest income from the bond in federal gross taxable income.10 The
bond buyer is willing to accept a lower interest rate because the interest income is not
subject to federal income taxes. The lower interest rate arising from the tax-exempt
status subsidizes state and local investment in capital projects. For example, if the
taxable bond interest rate is 7.00%, the after-tax return for a taxpayer in the 35%
income tax bracket who buys a taxable bond is 4.55%. Thus, a tax-exempt bond that
offers a 4.55% interest rate would be just as attractive to the investor as the taxable
bond, all else equal. For more on tax-exempt bonds generally, see CRS Report
RL30638, Tax-Exempt Bonds: A Description of State and Local Government Debt,
by Steven Maguire.
Interest Rate Spread. In 2005, the average high-grade corporate bond rate
was 5.24% and the average high-grade municipal (tax-exempt) bond rate was 4.29%
(see Table 1).11 The actual interest rate spread, the difference between the two
interest rates, is smaller empirically than the earlier example because many tax-
exempt bond buyers are below the 35% marginal tax bracket. Individuals in income
tax brackets below 35% would require a higher tax-exempt bond interest rate because
lower tax rates mean less tax savings from tax-exempt bonds.12 The lower tax
bracket taxpayers bid up the tax-exempt bond interest rate closer to the taxable bond
interest rate.
Table 1 reports the interest rate of corporate bonds and tax-exempt municipal
bonds of like maturity for 1980 through 2005. Bonds issued by state and local
governments are usually called “municipal bonds” by the investment community.
9 (...continued)
Activity (Washington, D.C.: The Urban Institute Press, 1991).
10 The discussion here does not address the effect of state taxes on the tax-exempt debt of
other states. For example, taxpayers in Virginia must pay Virginia income taxes on the tax-
exempt (exempt from federal income taxes) debt of other states. However, Virginia
taxpayers do not have to pay income taxes on interest earned on Virginia bonds.
11 Interest rate averages are composites of a variety of bond issues and provide a good
benchmark for market interest rates for municipal bonds.
12 For example, someone in the 10% income tax bracket would find tax-exempt bonds
attractive only if the interest rate were 6.37%. Or, looking at the problem from a different
perspective, the marginal tax rate below which tax-exempt bonds are not attractive is
16.58%. Thus, taxpayers in marginal tax brackets below this rate would not find tax-
exempt bonds attractive investments because the market interest rate on municipal bonds
would be too low. Taxpayers in the 15% marginal tax bracket would receive a higher after-
tax return though buying taxable bonds and paying taxes on the interest income at the 15%
rate.

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Generally, the two rates move in tandem, with the taxable corporate bond interest rate
always higher than the tax-exempt municipal bond interest rate.
Table 1. Yield on Tax-Exempt and Corporate Bonds of
Equivalent Risk, the Yield Spread, and the Yield Ratio:
1980 to 2005
High Grade
AAA
Yield Ratio
Tax-Exempt
Corporate
Yield Spread
Year
(tax-exempt/
Yield
Yield
(%)
corporate)
(%)
(%)
1980
8.51
11.94
3.43
0.71
1981
11.23
14.17
2.94
0.79
1982
11.57
13.79
2.22
0.84
1983
9.47
12.04
2.57
0.79
1984
10.15
12.71
2.56
0.80
1985
9.18
11.37
2.19
0.81
1986
7.38
9.02
1.64
0.82
1987
7.73
9.38
1.65
0.82
1988
7.76
9.71
1.95
0.80
1989
7.24
9.26
2.02
0.78
1990
7.25
9.32
2.07
0.78
1991
6.89
8.77
1.88
0.79
1992
6.41
8.14
1.73
0.79
1993
5.63
7.22
1.59
0.78
1994
6.19
7.96
1.77
0.78
1995
5.95
7.59
1.64
0.78
1996
5.75
7.37
1.62
0.78
1997
5.55
7.26
1.71
0.76
1998
5.12
6.53
1.41
0.78
1999
5.43
7.04
1.61
0.77
2000
5.77
7.62
1.85
0.76
2001
5.19
7.08
1.89
0.73
2002
5.05
6.49
1.44
0.78
2003
4.73
5.67
0.94
0.83
2004
4.63
5.63
1.00
0.82
2005
4.29
5.24
0.95
0.82
Source: Council of Economic Advisors, Economic Report of the President, February 2006, Table B-
73.
Tax-Exempt Bonds and the AMT. Unlike tax-exempt government purpose
bonds, the interest income from tax-exempt private activity bonds is included in the
alternative minimum tax (AMT) base. The AMT is a tax that is levied in parallel
with the income tax and is intended to ensure that taxpayers with many deductions
and exemptions pay a minimum percentage of their gross income in taxes. Because
private activity bonds are included in the AMT the bonds usually carry a slightly

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higher interest rate (approximately 50 basis points13 higher) than do tax-exempt
government-purpose bonds, all else equal.14 However, the private activity bond rate
is still lower than the taxable bond rate. For more on the AMT, see CRS Report
RL30149, The Alternative Minimum Tax for Individuals, by Gregg A. Esenwein.
Repealing the AMT or exempting some bonds issued for qualified private
activities from the AMT would increase investor demand for those bonds. The
increased attractiveness of those bonds would eventually lead to lower interest costs
for the issuer of private activity bonds.
Technical Definition of Private Activity Bonds. A private activity bond
is one that primarily benefits or is used by a private entity. The tax code defines
private business (or private entity) use as “...use (directly or indirectly) in a trade or
business carried on by any person other than a governmental unit. For purposes of
the preceding sentence, use as a member of the general public shall not be taken into
account.”15 Two conditions or tests are used to assess the status of a bond issue with
regard to the private entity test. Satisfying both conditions would mean the bonds are
taxable private activity bonds. Bonds are private activity bonds and not tax-exempt
if both of the following conditions are met:16
! [use test] more than 10% of the proceeds of the issue are to be used
for any private business use,... [and]
! [security test] if the payment on the principal of, or the interest on,
more than 10% of the proceeds of such issue is (under the terms of
such issue or any underlying arrangement) directly or indirectly
secured by any interest in (1) property used or to be used for a
private business use, or (2) payments in respect to such property. Or
[if the payment is] to be derived from payments (whether or not to
the issuer) in respect of property, or borrowed money, used or to be
used for a private business use.
If a bond issue passes both tests, the bonds are taxable and would carry a higher
interest rate. Nevertheless, bond issues that pass both tests can still qualify for tax-
exempt financing if they are identified in the tax code as qualified private activities.
Thus, when those in the bond community refer to tax-exempt private activity bonds,
the more technically correct reference is tax-exempt, qualified private activity bonds.
What Are the Qualified Private Activities? A number of qualified private
activities are granted special status in the tax code (see Table 2). These activities are
called “qualified private activities” because they qualify for tax-exempt financing
even though they would likely “pass” the two part private activity test which would
otherwise disallow tax-exempt financing. The list of qualified private activities has
13 50 basis points is equivalent to one-half of a percentage point or 0.50%.
14 Jacob Fine, “AMT Spreads on the Rise,” The Bond Buyer, July 26, 2000, p. 1.
15 26 U.S.C. 141(b)(6)(A)
16 26 U.S.C. 141(b)

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gradually expanded to 21 activities from the 12 that were originally defined by the
Revenue and Expenditure Control Act of 1968. The Tax Reform Act of 1986 kept
most of the activities listed in the 1968 Act and reorganized the private activity bond
section of the federal tax code.
The Revenue and Expenditure Control Act of 1968. The 1968 Act
legislated that the interest payments on industrial development bonds (IDBs, the
original private activity bonds) were to be included in taxable income. This was a
shift from the previous Internal Revenue Service (IRS) position, which held that the
interest on these bonds was not taxable income. The motivation behind the change
offered in the 1968 Act was based “...on the theory that industrial development bonds
described in the proposed [IRS] regulations were not ‘obligations of a State or any
political subdivision’ within the meaning of section 103 since the primary obligor
was a not a State or political subdivision.”17 The 1968 Act also (1) established the
basis for the current private use and private security tests; (2) created exceptions to
the taxability provision for small issuers; (3) and specified a group of private
activities that would qualify for tax-exempt bond financing.
The Tax Reform Act of 1986. The 1986 Act, which rewrote the Internal
Revenue Code of 1954, renewed most of the previously defined private activities
identified in the 1968 Act. Notably, TRA 1986 added one private activity, qualified
hazardous waste facilities, and limited the exemption for some previously acceptable
private activities, including construction of sports facilities and privately owned (as
opposed to government owned) airports, docks, wharves, and mass-commuting
facilities. In Table 2, the activities that must be government owned to qualify for
tax-exempt financing are identified in italics. Before and after enactment of TRA
1986, there were several other additions to the list of qualified private activities. The
date of introduction for each qualified private activity is included in the last column
of Table 2.
Empowerment Zones and New York Liberty Zones. In addition to
private activities listed in Table 2, there are special zones where tax-exempt private
activity bonds can be issued for qualified economic development projects in that
zone. The Empowerment Zone / Enterprise Community (EZ) program has been
implemented in rounds and each round is subject to different debt rules. Round I EZ
bonds are subject to the state volume cap and each zone can have only $3 million of
EZ bonds outstanding.18 There are also limits on the amount of Round I EZ bonds
any one borrower can have outstanding. An EZ borrower can have an aggregate of
$20 million outstanding for all EZ projects throughout the country.
Round II EZs (and all EZs established after December 31, 2001) are subject to
designation “lifetime” caps depending on the urban vs. rural designation and
population for urban EZs. For the lifetime of the EZ designation, rural EZs can issue
17 U.S. Congress, Conference Committees, 1968, Revenue and Expenditure Control Act of
1968, conference report to accompany H.R. 15414, House Report No. 1533, 90th Cong.,
2nd sess. (Washington: GPO, 1968), p. 32.
18 A special EZ for the District of Columbia allows up to $15 million of outstanding EZ
bond debt.

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up to $60 million; urban EZs with population less than 100,000 can issue up to $130
million; and urban EZs with population greater than 100,000 can issue up to $230
million. In contrast to Round I EZs, there are no limits on the amount any one entity
can borrow for Round II EZs.19
The New York Liberty Zone (NYLZ) was established in the wake of the
September 11, 2001 terrorist attacks upon New York City.20 The tax benefits created
to foster economic revitalization within the NYLZ included a “Liberty Bond”
program. The program allows New York State (in conjunction and coordination with
New York City) to issue up to $8 billion of tax-exempt, private activity bonds for
qualified facilities in the NYLZ. Qualified facilities follow the exempt facility rules
within section 142 of the IRC. The original deadline to issue the bonds was January
1, 2005, but was recently extended to January 1, 2010, by P.L. 108-311.
Gulf Opportunity Zone Act of 2005. The hurricanes that struck the gulf
region in late summer 2005 prompted Congress to create a tax-advantaged economic
development zone intended to encourage investment and rebuilding in the gulf
region. The Gulf Opportunity Zone (GOZ) is comprised of the counties where the
Federal Emergency Management Agency (FEMA) declared the inhabitants to be
eligible for individual and public assistance. Based on proportion of state personal
income, the Katrina-affected portion of the GOZ represents approximately 73% of
Louisiana’s economy, 69% of Mississippi’s, and 18% of Alabama’s.21
Specifically, the “Gulf Opportunity Zone Act of 2005” (P.L. 109-35, GOZA
2005) contains two provisions that would expand the amount of private activity
bonds outstanding and language to relax the eligibility rules for mortgage revenue
bonds. The most significant is the provision to increase the volume cap (see Table
3) for private activity bonds issued for Hurricane Katrina recovery in Alabama,
Louisiana, and Mississippi (identified as the Gulf Opportunity Zone, or “GO Zone”).
GOZA 2005 would add $2,500 per person in the federally declared Katrina disaster
areas in which the residents qualify for individual and public assistance. The
increased volume capacity would add approximately $2.2 billion for Alabama, $7.8
billion for Louisiana, and $4.8 billion for Mississippi in aggregate over the next five
years. The legislation defines “qualified project costs” that can be financed with the
bond proceeds as (1) the cost of any qualified residential rental project (26 sec.
142(d)) and (2) the cost of acquisition, construction, reconstruction, and renovation
of (i) non residential real property (including fixed improvements associated with
such property) and (ii) public utility property (26 sec. 168(i)(10)) in the GOZ. The
19 See the following publication for more details on the EZ programs: U.S. Department of
Housing and Urban Development, Tax Incentive Guide for Businesses in the Renewal
Communities, Empowerment Zones, and Enterprise Communities: FY2003. The report is
available at the Department of Housing and Urban Development website:
[http://www.hud.gov/offices/cpd/economicdevelopment/library/taxguide2003.pdf].
20 Section 301 of the Job Creation and Worker Assistance Act of 2002, P.L. 107-147, created
the various NYLZ tax benefits (26 U.S.C. 1400L). The tax-exempt bond component can be
found in 26 U.S.C. 1400L(d).
21 See CRS Report RL33154, The Impact of Hurricane Katrina on the State Budgets of
Alabama, Louisiana, and Mississippi, by Steven Maguire.

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additional capacity would have to be issued before January 1, 2011. The provision
is estimated to cost $1.556 billion over the 2006-2015 budget window.22
The second provision allows for advance refunding of certain tax-exempt bonds.
Under GOZA 2005, governmental bonds issued by Alabama, Louisiana, and
Mississippi may be advance refunded an additional time and exempt facility private
activity bonds for airports, docks, and wharves once. Private activity bonds are
otherwise not eligible for advance refunding. Following is a brief description of
advance refunding and how the GOZA 2005 provision confers a significant tax
benefit to the gulf states.
Refunding is the practice of issuing new bonds to buy back outstanding bonds
to potentially lower interest costs. Advance refunding is the practice of allowing the
new bonds to be outstanding for longer than 90 days. Advance refunding, thus,
allows for the existence of two sets of federally tax-exempt bond issues to be
outstanding at the same time for a single project. GOZA 2005 allows the states of
Alabama, Louisiana, and Mississippi to advance refund $1.125 billion, $4.5 billion,
and $2.25 billion, respectively. This provision is estimated to cost $741 million over
the 2006-2015 budget window.23 For more on advance refunding, see CRS Report
RL30638, Tax-exempt Bonds: A Description of State and Local Government Debt,
by Steven Maguire.
IRS Review of Tax-Exempt Status. The IRS often reviews the tax-exempt
status of outstanding bonds issued for qualified private activities. If the bonds that
were originally issued as tax-exempt are found to no longer qualify (meaning that
they pass both the security and use tests) the interest on the bonds becomes taxable.
Technically, bond holders are the recipient of the tax benefit and are responsible for
remitting forgone taxes to the Treasury when a tax-exempt bond fails to qualify. A
retroactive taxability finding means all previous tax benefits to the bond holder
would have to be returned to the Treasury. A prospective taxability finding means
all future interest payments would be taxable to the bond holder. However, in most
cases, the IRS will settle the apparent violation by requiring that the issuer, not the
bond holders, pay a monetary penalty and that the issuer change the circumstances
that led to the non-compliance finding.24
What Is the Private Activity Volume Cap?25 The federal government has
limited the amount of private activity bonds that states can issue to a subset of the 21
activities listed in Table 2 and to EZ bonds. The third column of Table 2 identifies
the 13 activities (of the 21) that are subject to an annual state volume cap. The
22 The 10-year revenue loss estimates for GOZA 2005 are from the Joint Committee on
Taxation, Estimated Revenue Effects of H.R. 4440, the ‘Gulf Opportunity Tax Relief Act of
2005,’ as passed by the House of Representatives and the Senate on Dec. 16, 2005, JCX-89-
05, Dec. 20, 2005.
23 JCT, Dec. 20, 2005.
24 See the following IRS website for more information on tax-exempt bond rulings and
findings: [http://www.irs.gov/compliance/index.html].
25 26 U.S.C. 146.

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CRS-10
annual cap was increased from the greater of $50 per capita or $150 million in 2000,
to the greater of $80 per capita or $246.610 million in 2006 (and is now adjusted for
inflation). For small states, the $246.610 million minimum provides a more generous
volume cap than the per capita allocation. Table 3 lists the volume cap amount in
2005 and 2006 for all states and territories and compares the 2005 cap to state
personal income in 2004.
Table 2. Qualified Private Activities
Internal
Type of Private Activity
Subject to
Year
Revenue Code
(Italicized activities must be owned by the
Volume
Established
Section
issuing government to qualify)
Cap
Sec. 142
Exempt facility bonds
Sec. 142(c)
Airports
No
1968
Sec. 142(c)
Docks and wharves
No
1968
Sec. 142(c)
Mass commuting facilities
Yes
1981
Sec. 142(e)
Water furnishing facilities
Yes
1968
Sec. 142(a)(5)
Sewage facilities
Yes
1968
Sec. 142(a)(6)
Solid waste disposal facilities
Yes/Noa
1968
Sec. 142(d)
Qualified residential rental projects
Yes
1968
Sec. 142(f)
Local electric energy or gas furnishing
Yes
1968
facility
Sec. 142(g)
Local district heating and cooling facilities
Yes
1982
Sec. 142(h)
Qualified hazardous waste facilities
Yes
1986
Sec. 142(I)
High-speed intercity rail facilities
Yesb
1988
Sec. 142(j)
Environmental enhancements of
No
1992
hydroelectric generating facilities
Sec. 142(k)
Qualified public educational facilities
Noc
2001
Sec. 142(l)
Qualified green building and sustainable
Noc
2005
design projects
Sec. 142(m)
Qualified highway and surface freight
Noc
2005
transfer facilities
Sec. 143
Mortgage revenue bonds
Sec. 143(a)
Qualified mortgage bond
Yes
1968
Sec. 143(b)
Qualified veterans’ mortgage bond
No
1968
Sec. 144(a)
Qualified small issue bond
Yes
1968
Sec. 144(b)
Qualified student loan bond
Yes
1976
Sec. 144(c)
Qualified redevelopment bond
Yes
1968
Sec. 145
Qualified 501(c)(3) bond
No
1968
a. Exempt from the cap if governmentally owned. Subject to the cap if privately owned.
b. 25% of the bond issue is included in the cap. If the facility is owned by a governmental unit, no cap
allocation is required. In addition, if the facility is not governmentally owned, to qualify for tax-
exempt status, the owner must elect not to claim any depreciation deductions or investment tax
credits with respect to the property financed with the bonds.
c. Educational facility bonds are subject to a separate cap: the greater of $10 per capita or $5 million.
Green building bonds are subject to a national aggregate amount of $2 billion through the
expiration of the program, scheduled for October 1, 2009. Highway bonds are subject to the
following annual issuance limits: $130 million in 2005; $750 million each year for 2006 through
2009; $1.87 billion in 2010; and $2 billion each year for 2011 through 2015, zero thereafter.

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CRS-11
Of the 13 activities subject to an annual volume cap, two are treated differently
than the others, and two others are subject to a separate cap. First, states are required
to count only 25% of the bonds issued for high-speed intercity rail facilities (26
U.S.C. 142(I)) against the annual cap. If the facility is government owned and
operated, no cap allocation is required. Second, bonds issued for solid waste disposal
facilities (26 U.S.C. 142(a)(6)) are not subject to the cap if the facility is government
owned and operated. Qualified public educational facilities (26 U.S.C. 142(k)), are
subject to a separate annual cap which is the greater of $10 per capita or $5 million.
The two newest activities, bonds for green buildings (26 U.S.C. 142(l)) and highway-
freight transfer facilities (26 U.S.C. 142(m)), are subject to a separate cap. Green
buildings are subject to a $2 billion lifetime (not annual) cap and transfer facilities
are subject to annual national caps ranging from $130 million for 2005 rising to $2
billion from 2011 through 2015 (for a total of $15 billion).26
The total 2006 bond volume cap for all states and the District of Columbia is
over $26 billion. California is allowed to issue over one-tenth of total new volume
or $2.9 billion (see Table 3). However, as measured against total California personal
income, the new volume cap is considerably less than the national average. For every
$100 of 2004 personal income in California, approximately $0.23 of private activity
debt can be issued whereas the U.S. average is $0.43.27 In contrast, Wyoming, the
least populous state, could issue up to $1.38 of private activity debt for every $100
of personal income (see the last column of Table 3).
Table 3. Annual State Private Activity Bond Volume Cap, 2005
and 2006
2004
2005 Cap per
2005 Volume
2006 Volume
Personal
$100 of 2004
State
Cap
Cap
Income
Personal
($ millions)
($ millions)
($ millions)
Income
Alabama*
$362.4
$364.6
125,917
$0.29
Alaska
$239.2
$246.6
22,582
$1.06
Arizona
$459.5
$475.1
163,365
$0.28
Arkansas
$239.2
$246.6
70,810
$0.34
California
$2,871.5
$2,890.6
1,256,959
$0.23
Colorado
$368.1
$373.2
165,943
$0.22
Connecticut
$280.3
$280.8
159,055
$0.18
Delaware
$239.2
$246.6
29,778
$0.80
District of Columbia
$239.2
$246.1
28,674
$0.83
Florida
$1,391.8
$1,423.2
547,222
$0.25
Georgia
$706.4
$725.8
265,330
$0.27
Hawaii
$239.2
$246.6
40,613
$0.59
Idaho
$239.2
$246.6
37,755
$0.63
26 For more on the transfer facility private activity bond program, see U.S. Department of
Transportation, “Applications for Authority for Tax-Exempt Financing of Highway Projects
and Rail-Truck Transfer Facilities,” 71 Federal Register 642, Jan. 5, 2006.
27 The states were each given equal weight for the average calculation. The values in the last
column of Table 2 were summed then divided by 51.

---

CRS-12
2004
2005 Cap per
2005 Volume
2006 Volume
Personal
$100 of 2004
State
Cap
Cap
Income
Personal
($ millions)
($ millions)
($ millions)
Income
Illinois
$1,017.1
$1,021.1
436,731
$0.23
Indiana
$499.0
$501.8
187,714
$0.27
Iowa
$239.2
$246.6
90,289
$0.26
Kansas
$239.2
$246.6
84,282
$0.28
Kentucky
$331.7
$333.9
114,881
$0.29
Louisiana*
$361.3
$361.9
124,551
$0.29
Maine
$239.2
$246.6
40,264
$0.59
Maryland
$444.6
$448.0
218,138
$0.20
Massachusetts
$513.3
$511.9
268,215
$0.19
Michigan
$809.0
$809.7
323,142
$0.25
Minnesota
$408.1
$410.6
182,924
$0.22
Mississippi*
$239.2
$246.6
71,558
$0.33
Missouri
$460.4
$464.0
176,137
$0.26
Montana
$239.2
$246.6
24,893
$0.96
Nebraska
$239.2
$246.6
54,756
$0.44
Nevada
$239.2
$246.6
77,994
$0.31
New Hampshire
$239.2
$246.6
48,134
$0.50
New Jersey
$695.9
$697.4
359,545
$0.19
New Mexico
$239.2
$246.6
49,849
$0.48
New York
$1,538.2
$1,540.4
735,022
$0.21
North Carolina
$683.3
$694.7
249,799
$0.27
North Dakota
$239.2
$246.6
19,918
$1.20
Ohio
$916.7
$917.1
358,920
$0.26
Oklahoma
$281.9
$283.8
98,974
$0.28
Oregon
$287.6
$291.3
107,732
$0.27
Pennsylvania
$992.5
$994.4
413,730
$0.24
Rhode Island
$239.2
$246.6
36,453
$0.66
South Carolina
$335.8
$340.4
114,069
$0.29
South Dakota
$239.2
$246.6
23,787
$1.01
Tennessee $472.1
$477.0
177,057
$0.27
Texas
$1,799.2
$1,828.8
679,683
$0.26
Utah
$239.2
$246.6
63,562
$0.38
Vermont
$239.2
$246.6
20,363
$1.17
Virginia
$596.8
$605.4
264,652
$0.23
Washington
$496.3
$503.0
218,987
$0.23
West Virginia
$239.2
$246.6
46,966
$0.51
Wisconsin
$440.7
$442.9
177,154
$0.25
Wyoming
$239.2
$246.6
17,377
$1.38
Total / Average
$26,083.9
$26,438.3
9,674,208
$0.43
Note: *Under the Gulf Opportunity Zone Act of 2005, P.L. 109-135, Alabama, Louisiana, and
Mississippi, can issue before Jan. 1, 2011, in aggregate, an additional (CRS estimated) $2.17 billion,
$7.88 billion, and $4.92 billion, respectively.
Source: Personal income data are from the Bureau of Census, State Annual Personal Income,
available at [http://www.bea.gov/bea/regional/spi/]. Bond volume cap information for 2005 is from
the Bond Buyer 2006 Yearbook, 2006.

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CRS-13
This disparity arises from the two part volume capacity calculation which
provides for a minimum of $246.610 million, regardless of state population. In
addition, states that have total personal income below the national average would
also have a relatively high debt allowance as measured against personal income. The
last column of Table 3 provides a comparative measure of the state-by-state volume
capacity based on 2004 personal income.
Allocation by Type of Activity. Each state independently determines the
allocation of its volume capacity. Table 4 identifies the total cap distribution for
private activities in 2003, 2004, and 2005. The category names used by the Bond
Buyer newspaper, the source of the data, differ from the more detailed names for the
private activities used in the tax code and listed in Table 2. Nevertheless, the Bond
Buyer data roughly reflect the cap allocation preferences of the states and their
subdivisions. Note that 53.6% of the available volume capacity for 2005 was not
used and carried forward to 2006 ($26,337 million).
Table 4. Private Activity Bond Volume by
Type of Activity in 2003, 2004, and 2005
Issued in
Private Activity
($ millions)
2003
2004
2005
Total Volume Capacity Available
$36,335.5
$43,087.9
$49,141.7
New Volume Capacity
24,185.2
25,741.3
26,079.1
Carryover from previous years
12,150.3
17,346.6
23,062.6
Carry forward to next year
18,444.3
22,949.9
26,337.1
Single-family Mortgage Revenue
4,050.9
5,204.2
6,507.1
Multi-family Housing
5,672.8
5,007.2
5,561.7
Student Loans
3,141.2
4,722.6
5,124.0
Exempt Facilities
1,785.7
1,646.0
1,914.7
Industrial Development
637.3
797.1
999.9
Abandon Capacity
344.0
838.8
910.0
Housing not Classified
799.0
186.4
821.6
Mortgage Credit Certificates
484.9
416.5
492.8
Other Activities
976.1
1,319.5
485.1
Portion of Available Capacity
Total Volume Capacity Available
100.0%
100.0%
100.0%
New Volume Capacity
66.6%
59.7%
53.1%
Carryover from previous years
33.4%
40.3%
46.9%
Carry forward to next year
50.8%
53.3%
53.6%
Single-family Mortgage Revenue
11.1%
12.1%
13.2%
Multi-family Housing
15.6%
11.6%
11.3%
Student Loans
8.6%
11.0%
10.4%
Exempt Facilities
4.9%
3.8%
3.9%
Industrial Development
1.8%
1.9%
2.0%
Abandon Capacity
0.9%
1.9%
1.9%
Housing not Classified
2.2%
0.4%
1.7%
Mortgage Credit Certificates
1.3%
1.0%
1.0%
Other Activities
2.7%
3.1%
1.0%

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CRS-14
Source: “State Allocations of Private Activity Bonds in 2003,” The Bond Buyer, May 26, 2004, p. 6;
“State Allocations and Use of Private Activity Bonds in 2004,” The Bond Buyer, May 2, 2005, p. 7;
and “State Allocations and Use of Private Activity Bonds in 2005,” The Bond Buyer, May 1, 2006,
p. 7.
Unused volume capacity can be carried forward for up to three years, as long as
the state identifies the project for which the cap space is dedicated. Bond capacity
that has not been used after three years is then abandoned. Abandoned bond capacity
was less than 2% of total available capacity in 2004 and 2005.
Other Restrictions on Private Activity Bonds. The use of private
activity bonds is also limited by other technical restrictions. In general, loosening the
restrictions would allow issuers to reduce administrative and compliance costs.
However, the relaxed restrictions would exacerbate the concerns (i.e., the
economically inefficient allocation of capital) surrounding tax-exempt bonds that
were discussed earlier in the report. Following is a list of the more technical rules
along with the section in the tax code where the rule appears.
! The maturity of the bonds cannot be greater than 120% of the
economic life of the asset purchased with the bonds (26 U.S.C.
147(b));
! less than 25% of the bond proceeds can be used to acquire land
(except for qualified first-time farmers) (26 U.S.C. 147(c));
! proceeds of the bond issue cannot be used to purchase existing
property unless greater than 15% of the cost of acquiring the
property is spent on rehabilitating the property (26 U.S.C. 147(d));
! public approval of bonds, either through public hearing and notice
or voter referendum, is required for private activity bonds (26 U.S.C.
147(f)); and
! issuance costs cannot be any greater than 2% of the bond proceeds
(3.5% for mortgage bond issues of less than $20 million) (26 U.S.C.
147(g)).
! private activity bonds cannot be advance refunded.28
Conclusion and Further Reading
The history, tax laws, financial properties, and economic effects of tax-exempt
bonds are all exceedingly complex and continually evolving. This report is intended
28 Current refunding is the practice of issuing bonds to replace existing bonds. Issuers
typically do this to “lock-in” lower interest rates or more favorable borrowing terms.
Current refunding is allowed as long as the “old” bonds are redeemed within 90 days of the
issuance of the refunding bonds. Advance refunding is the practice of issuing new bonds
to replace existing bonds, but not immediately (within 90 days) retiring the old bonds. Thus,
two sets of tax-exempt bonds are outstanding for the same project.

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CRS-15
to clarify part of the tax-exempt bond labyrinth. Nevertheless, the reader may wish
to explore tax-exempt bonds in more depth or from a more general, less technical
perspective. The following reading list should equip the reader with a good
foundation for pursuit of either objective.
Bruce Davie and Dennis Zimmerman, “Tax-Exempt Bonds After the South Carolina
Decision,” Tax Notes, vol. 39, no. 13, June 27, 1988, p. 1573.
Peter Fortune, “Tax-Exempt Bonds Really Do Subsidize Municipal Capital!,”
National Tax Journal, vol. 51, no. 1, March 1998, p. 43.
Roger H. Gordon and Gilbert E. Metcalf, “Do Tax-Exempt Bonds Really Subsidize
Municipal Capital?,” National Tax Journal, vol. 44, no. 4, part 1, December
1991, p. 71.
George J. Marlin and Joe Mysak, The Guidebook to Municipal Bonds: The History,
The Industry, The Mechanics (New York: The American Banker/Bond Buyer,
1991).
David J. Ott and Allan H. Meltzer, Federal Tax Treatment of State and Local
Securities (Washington, D.C.: The Brookings Institution, 1963).
Judy Wesalo Temel, The Fundamentals of Municipal Bonds, 5th Edition (New York:
John Wiley and Sons, 2001).
Dennis Zimmerman, The Private Use of Tax-Exempt Bonds: Controlling Public
Subsidy of Private Activity (Washington, D.C.: The Urban Institute Press, 1991).

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