Dec. 29 (Bloomberg) -- Congressional Democrats are seeking to expand funding for airport runways, housing projects and sewage-treatment plants through a new tax break for municipal bondholders.

The proposal is designed to make so-called private-activity bonds more attractive by exempting the interest on them from the alternative minimum tax. Richard Neal, chairman of the House Ways and Means subcommittee that drafts tax measures, wants to include the plan in economic recovery legislation that President-elect Barack Obama has made a top priority.

“I am hopeful that my bill, which will increase demand and lower costs for state and local governments, will be a central feature of our stimulus bill next month,” said Neal, a Massachusetts Democrat.

Neal’s proposal would reverse 23 years of policy. It aims to increase demand for private-activity bonds by mutual funds and individual investors who often avoid them because of the higher taxes and complicated paperwork under the alternative minimum tax. The legislation would apply to both newly issued bonds and those traded on the secondary market.

Neal’s bill is one of at least three proposals favoring the municipal bond market gaining steam as Democrats seek ways to fulfill Obama’s promise to steer federal funding to infrastructure projects as part of a stimulus package worth as much as $850 billion over two years.

Tax Implications

Senate Finance Committee Chairman Max Baucus, a Montana Democrat, earlier this month said he is drafting a measure worth at least $500 billion that, among other things, would allow governments to issue additional private-activity bonds, also known as AMT bonds because of their tax implications.

Lawmakers also are considering proposals to exempt from the AMT other types of bonds, such as those issued by non-profit hospitals and colleges, and to allow banks to deduct more costs from purchasing and carrying tax-exempt bonds than they currently may write off.

“The idea is, how can we stimulate activity?” said Charles Samuels, a lawyer at Mintz Levin Cohn Ferris Glovsky & Popeo PC in Washington, who advises the National Association of Health and Educational Facilities Finance Authorities. He is lobbying to expand Neal’s proposal to also repeal the AMT on bonds issued by non-profit organizations.

Old Proposal

While many of the ideas have been around for years, he said, the mix of the economic distress and changing political leadership is giving them new life.

“It’s taking an extreme situation to allow the political system to get unclogged,” he said.

Private-activity bonds are part of a subset of municipal bonds that are an exception to the securities’ general tax-exempt status due to the AMT.

AMT bonds made up 8.8 percent of the overall municipal bond market in 2007, with a sales volume of $38 billion, according to data compiled by Thomson Financial.

The AMT was created in 1969 to prevent 155 wealthy Americans from avoiding any tax by claiming excessive deductions, credits, and exemptions. When deductions for items such as medical expenses and state and local taxes become too large relative to income, the AMT imposes a flat exemption. Amounts over the exemption are taxed at 26 percent or 28 percent, depending on income.

Millions of Households

The AMT now affects about 4 million households a year. It is scheduled to affect 30.3 million households in 2009 unless Congress renews a measure to index the levy for inflation.

Taxpayers who may owe AMT must calculate their liabilities using both methods and pay the higher amount. Interest from most municipal bonds isn’t counted toward income under either method, with the exception of private-activity bonds and those issued by certain non-profit groups.

Investors who pay in the middle-income tax brackets of 25 percent might end up owing AMT if they have large amounts of interest from private-activity bonds; those who pay in the top tax bracket of 35 percent typically avoid AMT because they end up paying more under the regular system.

Repealing the AMT on individuals who buy the bonds would reduce borrowing costs, said Greg Principato, president of the Airports Council International-North America.

“Eliminating the AMT on airport bonds would provide significant savings, while also attracting more buyers” for the bonds, he said.

Student Loans

The largest AMT bond issued in 2007 was a $600 million student loan issue by Educational Funding of the South. Three other issues, all for airports in Miami, San Jose, California, and Washington, D.C., were between $530 million and $551 million.

Housing was the leading purpose for AMT financing in 2007, as it has been since the inception of AMT bonds in 1986. Minimum tax housing bonds rose 4 percent in 2007 to a record $21.7 billion.

This year’s credit crunch has made it more expensive for local authorities to borrow money for projects using AMT bonds.

Eleven governmental organizations such as the National League of Cities and U.S. Conference of Mayors, said in a letter to Neal this month that the premium AMT bonds pay over regular municipal bonds, usually about 25 basis points, has grown to as much as 100 basis points.

Yields in some cases are even higher than commercial bonds, an expense that has coincided with increased costs for completing infrastructure projects.

The groups urged Neal to expand his legislation to also repeal the AMT for corporations that buy the bonds.

To contact the reporters on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net

Last Updated: December 29, 2008 15:26 EST