Finance: Less Cash for the Cities

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Lacy Elementary School in Hondo, Texas, is so overcrowded that some classes meet in a makeshift room built into the balcony of the auditorium, and in two noisy rooms off the gym. The 500 pupils, mostly Mexican American, are packed so closely together that illnesses spread rapidly among them.

The Stambough General Hospital in Iron County, Mich., is so ancient and rickety that state authorities have ordered it closed by Nov. 26. The sick do not know where they will go after that.

These situations illustrate the social cost of a financial disaster: the near-collapse of the municipal bond market. Other results include a scaling down of planned airport improvements in Los Angeles, an increase in three-shift classroom sessions in the schools of Dade

County, Fla., and fears of flooding in Clinton Township, Mich., because not enough storm sewers are being built. State and local governments spend roughly $26 billion a year to build schools, hospitals, roads, sewers, airports and the like, and last year they raised almost $11 billion of the sum by selling bonds. So far this year their bond sales are running 26% below that pace.

Almost $3 billion in bonds that would have financed public construction—including a new school for Hondo and a modern hospital for Iron County—have proved totally unmarketable. Probably a much greater total of bonds has not been scheduled for sale because local officials fear that they would find no buyers. Michigan voters, for example, last year approved two issues totaling $435 million to finance antipollution and park-building programs, but state authorities have never tried to set a date for investment-banking houses to bid on them. They have reason for their timidity. About half of the investment-banking houses that were buying state and city bonds a year ago, for resale to banks and rich individual investors, have stopped doing so.

The immediate cause of this chaos is the congressional drive to close tax loopholes. Interest paid on municipal bonds has always been exempt from federal income tax, but the reform bill that the House passed in August would make such interest partially taxable for many individual investors. Banks, which normally buy 70% to 80% of all municipal bonds, would continue to collect tax-free interest, but their officers fear that if the bill is finally enacted it will be only a matter of time before that exemption is limited, too. The slowdown in municipal-bond sales has produced something close to a revolt among governors, mayors and county officials. Several of them appeared before the Senate Finance Committee last week to denounce all proposals to tax municipal-bond interest.