Packwood to Fight for Tax on Municipal Bonds

Senate Finance Committee Chairman Bob Packwood (R-Ore.), in an early showdown over one aspect of his tax revision plan, Friday vowed to fight to prevent wealthy individuals and profitable corporations from escaping all income taxes through ownership of tax-exempt municipal bonds, but he conceded that he would probably lose in committee next week.

The municipal bond market has been in a state of confusion since Wednesday, when investors first realized that Packwood was proposing that interest on current tax-exempt bonds be gradually made subject to a 20% minimum tax, beginning in 1987.

Flap Over Minor Issue

The flap over this comparatively minor issue suggests just how difficult it will be for the Finance Committee to agree on any overall tax revision package.

Meanwhile, Packwood and the Reagan Administration continued to spar over who should take the blame for the controversial proposal, which has drawn fire from a majority of the tax-writing panel. The dissident senators apparently were responding to complaints from local officials, institutional bondholders and Wall Street lobbyists.

Packwood said that the idea of taxing income from all current tax-exempt bonds--phased in over five years--was advanced by Treasury officials after they had examined an early draft of his plan. That draft would have subjected only bonds acquired after 1986 to the minimum tax. He said also that he had discussed the matter with Treasury Secretary James A. Baker III.

Administration officials, refusing to speak on the record, insisted that the Treasury did not first propose the idea of subjecting all tax-exempt bond income to the minimum tax, pointing out that no such plan was included in the original White House tax package.

Treasury Stand Disputed

“When informed of the proposal,” one Administration official said, “Treasury suggested it should be phased in or, alternatively, it should apply only to newly issued bonds.”

But Finance Committee aides insisted that the Treasury did not propose applying the rule only to newly issued bonds and that it was Treasury’s idea to apply the minimum tax to bonds regardless of when they had been acquired.

There is a crucial distinction between newly issued and newly acquired bonds.

Including only newly issued bonds under the minimum tax would be much less onerous to bondholders, because they would be free to trade all outstanding bonds--currently totaling about $600 billion--without worrying about tax consequences.

Tax Considerations

Taxing all bonds acquired after Jan. 1, 1987, would require any future purchaser of a bond to consider the possibility that the income from a tax-exempt bond might be subject to the minimum tax.

And taxing all current bondholders would mean that even those who do not trade their bonds might be subject to the minimum tax.

Under the minimum tax proposal, high-income individuals and profitable corporations that sometimes escape income taxes under current law by relying on various legal tax breaks would be required to pay at least some income tax.

The Public Securities Assn., which represents Wall Street firms engaged in bond trading, attacked the efforts to include tax-exempt income under the minimum tax, arguing that it would increase the financing costs of state and local government bonds by between $8 billion and $24 billion by 1990.

Cost to California

The association released a study that said California governments could face an additional $1.16 billion in financing costs if interest rates on tax-exempt bonds were forced up by half a percentage point.

A majority of the Finance Committee’s 20 members are critical of Packwood’s proposal and have insisted that the provision be removed from the tax package immediately. But Packwood said he would defend the proposal at the committee’s session on Monday, arguing that it was not fair to maintain an escape hatch that would allow thousands of wealthy individuals to avoid federal income taxes.