Tax Revolt: A tempest in municipal bonds

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The confusion began last week, when Senator Bob Packwood of Oregon, chairman of the Senate Finance Committee, unveiled his tax-reform plan. Buried in the 250-page document was a two-sentence proposal to subject tax-exempt securities, like municipal bonds, to an "alternative minimum tax." The idea was that upper-income people who use municipal bonds as a shelter and pay little or no taxes would be subject to a 20% tax on the interest from the securities.

When news of Packwood's proposal flashed across brokerage-house computer screens Wednesday morning, the municipal-bond market was thrown into turmoil. As prices plummeted, Prudential-Bache Securities and other firms temporarily shut down their municipal-bond operations. New York City officials, citing "chaotic market conditions," postponed a $450 million bond sale. Chicago's finance officers put a hold on a $50 million offering, fearing they would have to pay an extra 1.5% to 2% interest to woo jittery investors. Said John Noonan, a manager at John Nuveen & Co., the Chicago municipal-bond firm: "Packwood didn't know what the proposal would do to the markets. Now he knows."

Indeed he does. Reaction was so intense that the Oregon Senator's colleagues urged him to back off. New York Senator Daniel Patrick Moynihan deplored the idea because it would levy the tax retroactively on bondholders who had bought securities under the assumption that they would be tax exempt. Minnesota Senator David Durenberger circulated a letter signed by himself and nine other Senators on the 20-member Finance Committee decrying the "devastating impact" of Packwood's provision.

By week's end even Packwood conceded that his plan was doomed, and a semblance of order returned to the bond market. Even so, interest rates were higher than many municipalities had expected. Milwaukee County called for bids on $17,450,000 in tax-exempt bonds, hoping to pay interest of no more than 6.71%. Instead, investors would go no lower than 7.25%.

Last week's turmoil added to the uncertainty that has been plaguing the muncipal-bond market for months. In December the House passed a tax-reform bill that would place a 25% minimum tax on certain munis, including bonds to build stadiums and industrial parks. Investors and municipalities that depend on bond issues will not know where they stand until tax reform finally passes Congress or dies.