We’ve pointed out some of the abuses of Certificates of Participation by the Denver and Jefferson County School Districts. \u00a0However, there are times when COPs are good. \u00a0One good use of COPs is as a cash management tool. \u00a0Municipal bonds are usually non-taxable, which means their yields are lower than Treasuries of an equal term, especially in longer-terms, say, 10 years and over. \u00a0Since a municipality doesn’t pay \u00a0 income tax, it can lend at the higher Treasury rate, while borrowing at the lower municipal rate, assuming that its credit rating is good. \u00a0(I don’t care if Illinois has 30 years of gold stashed away, I’m not lending them a dollar for a hamburger to tide them over until next Tuesday.) \u00a0The municipality can make a little reliable money on the arbitrage.<\/p>\n

In essence, this is a tax-shift. \u00a0The Treasury isn’t collecting income taxes that bond holders would normally pay, so that tax money is, in effect, shifted to the municipality. \u00a0It’s the reason that Treasury yields are higher in the first place.<\/p>\n

Over the last couple of years, though, this hasn’t really been possible. \u00a0Municipal rates have stayed pretty steady, while long-term Treasuries have dropped precipitously as a result of all the various Quantitative Easings by the Fed. \u00a0This has deprived municipalities of a source of cash. \u00a0So while the stimulus was essentially a massive shift of debt from the states and municipalities to the Federal government, the feds are taking it back, inch by inch, by taking away this tax shift that had been available to the lower levels of government.<\/p>\n

I don’t think it’s coincidence that one of the tax loopholes being mentioned for closure is the municipal bond interest. \u00a0The feds would like to make this tax shift permanent by pushing up municipal yields above Treasuries. \u00a0Most of the focus has been on the fact that this would make borrowing more difficult and expensive for municipalities. \u00a0 But it would also close off this tax shift as well. \u00a0Both these facts will have the effect of making states and municipalities more dependent on federal funds.
\n