Industrial Revenue Bonds

Industrial Revenue Bonds (IRBs)

One of the ways in which state and local governments can subsidize private business is by providing low-cost financing via the issuance of bonds.

Corporations can borrow money by issuing bonds on their own in the commercial marketplace, in which case they must offer investors the prevailing rate of interest. When the bonds are issued instead through public entities, the securities become tax-exempt. That means that the investors who buy the bonds do not have to pay federal (and often state) tax on the interest income they receive. Because of this advantage, tax-exempt bonds typically carry a lower rate of interest. The difference between the interest rate on tax-exempt bonds and the interest rate on commercial corporate bonds constitutes the subsidy to the business.

The bonds issued by public entities for companies are part of a category of securities known as private-activity bonds. These are distinct from the bonds that governments issue for their own purposes, such as building schools or water-treatment plants. (Public-purpose bonds fall into two main categories: general-obligation bonds, which are backed by general tax revenues, and revenue bonds, which are backed by specific revenue streams, such as the fees paid by users of a public parking garage.) In theory, private-activity bonds are serving a general public purpose by encouraging economic development and job creation, but the immediate benefit is going to private entities.

Private-activity bonds are also known as pass-through or conduit bonds, because the obligation to repay the principal and interest rests with the private entity involved, not with the public entity that issues the bonds and lends the proceeds to the private entity. These bonds are essentially private transactions laundered through a public entity (such as an economic development authority) to become tax-exempt and thereby save in interest costs.

The best-known form of private-activity bonds are industrial revenue bonds (IRBs), which are also known as industrial development bonds.

How IRBs work

IRBs came into wide use in the period after World War II, when Southern states employed them to lure investment by Northern manufacturing companies. By the 1960s, private-activity bonds had become so common that the federal government grew concerned about the loss of revenues from tax-exempt interest. Starting in the late 1960s, Congress began imposing restrictions on the uses of bond proceeds as well as limits on the allowable volume of bonds that could be issued.

Today there are two permissible types of tax-exempt IRBs used for corporate subsidies:

  • Small Issue IRBs are restricted to the construction, expansion, or renovation of manufacturing facilities. They are generally limited to $1 million, but under certain circumstances that amount can go up to $10 million.
  • Exempt Facility IRBs have no size limits, but they can be used only for specific types of projects, such as water and sewer facilities, electricity and natural gas facilities, and certain types of rental housing. Certain facilities such as stadiums, convention centers, and parking garages that used to be allowed are now excluded.

There is a limit on the total amount of IRBs that can be outstanding for the same company nationwide. There are also limits on the volume of certain categories of private-activity bonds that can be issued by each state. Typically, half of the state ceiling is allotted to state agencies and the other half is allotted to local government entities within the state according to relative population. As a result, each issuing entity ends up with what is known as a volume cap.

Some states get around the ceilings by offering IRBs that are not tax-exempt. New Mexico, for example, has issued billions of dollars in such bonds for Intel Corp. alone. Taxable IRBs are not designed to provide low-cost financing. Instead, they are a device to allow a company to avoid paying standard property taxes. This is accomplished by putting the ownership of the factory in the name of a public entity. The bonds issued by the entity to finance construction are all purchased by the company that will occupy the factory. The lease payments made by the company go to pay off the bonds, so that the firm is essentially borrowing money from itself.

Another category of tax-exempt private-activity bonds are 501(c)(3) bonds. These are pass-through bonds issued by public entities on behalf of non-profit organizations. Such bonds are among the categories of private-activity bonds that do not count against volume caps.

In order to qualify for tax-exempt status, private-activity bond issues are subject to a "public approval" requirement. This requirement can be met by a voter referendum or a public hearing following "reasonable notice." This is commonly known as the TEFRA requirement because it was instituted by the Tax Equity and Fiscal Responsibility Act of 1982.

For more on federal regulations regarding IRBs, see the Internal Revenue Service website: http://www.irs.gov/taxexemptbond/index.html.

Researching IRBs

Issuers of tax-exempt bonds are required to produce a document called an Official Statement that serves as a prospectus for prospective investors. These documents can be obtained from a website known as EMMA (Electronic Municipal Market Access) produced by the Municipal Securities Rulemaking Board. Note, however, that if the bonds are sold via a private placement rather than to the public, no Official Statement will be available.