GA 1.13: GGD-93-104

United States General Accounting Office

Report to the Chairman, Subcommittee on Human Resources and

Intergovernmental Relations, Committee
on Government Operations, House of
Representatives

TAX POLICY AND
ADMINISTRATION

Improvements for
More Effective
Tax-Exempt Bond
Oversight

This report, prepared for the Subcommittee in response to a former Chairman's request,
discusses (1) the Internal Revenue Service's (IRS) role in ensuring compliance with tax-exempt
bond provisions in the Internal Revenue Code and how its efforts can be improved and
(2) policy changes that could enhance IRS' ability to increase compliance with these provisions.
It also contains recommendations to the Commissioner of Internal Revenue and matters for
congressional consideration to improve tax-exempt bond oversight.

As agreed with your office, unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days from the date of this letter. At that time, we will send copies to interested parties and make copies available to others upon request.

The major contributors to this report are listed in appendix III. Please contact me on
(202) 512-5407 if you or your staff have any questions concerning this report.

Sincerely yours,

Jennie S. Stathis

Jennie S. Stathis

Director, Tax Policy and

Administration Issues

Purpose

Outstanding long-term tax-exempt bond volume doubled from 1968 to
1990, to about $796 billion, while forgone related federal tax revenues
grew proportionately, exceeding $20 billion in 1990. Coinciding with this
growth, bond financings became more complex. Congress became
concerned about this growth, not only because of forgone revenues but
also because of the increasing use of tax-exempt bonds to benefit private
parties and issuers earning profits by investing bond proceeds in securities
at higher interest rates. In response, Congress expanded restrictions on
tax-exempt bonds.

Given these changes, the Subcommittee on Human Resources and Intergovernmental Relations, House Committee on Government Operations, asked GAO to review the Internal Revenue Service's (IRS) role in ensuring compliance with tax-exempt bond provisions and to determine whether improvements were needed.

Background

Results in Brief

About 39,000 state and local governments and thousands of special
authorities and governmental districts can issue tax-exempt bonds. In
1990, issuers sold 11,500 issues and raised $162.3 billion. The bonds can be
used, within limits, to finance public-purpose projects, certain nonprofit
organizations' projects, and certain private for-profit activities.
Tax-exempt bonds provide a federal subsidy to issuers because investors
accept lower interest rates to obtain income exempt from federal tax.
Thus, issuers' costs are lower. However, bond issuers must comply with an
extensive array of Internal Revenue Code provisions. (See app. I.) Issuers
generally rely on bond counsels-attorneys specializing in tax-exempt
bonds to ensure that proposed bonds comply with federal laws and
regulations. IRS is responsible for overseeing that tax-exempt bonds
comply with these requirements.

IRS relies to a large extent on voluntary compliance with tax-exempt bond requirements, as it does for other Internal Revenue Code requirements. As a key component of its overall strategy to promote voluntary compliance with tax requirements, IRS relies on deterring the abuse of these requirements through traditional enforcement approaches to detect and punish noncompliance. However, IRS' principal tax-exempt bond enforcement effort, the Expanded Bond Audit Program, has concentrated almost exclusively on possible noncompliance cases that were identified by others and that were part of an alleged surge in abusive bonds issued in anticipation of the stricter requirements in the Tax Reform Act of 1986.