Less Cash for the Cities

Lacy Elementary School in Hondo, Texas, is so overcrowded that some classes meet in a makeshift room built into the balcony of the auditorium, and in two noisy rooms off the gym. The 500 pupils, mostly Mexican American, are packed so closely together that illnesses spread rapidly among them.

The Stambough General Hospital in Iron County, Mich., is so ancient and rickety that state authorities have ordered it closed by Nov. 26. The sick do not know where they will go after that.

These situations illustrate the social cost of a financial disaster: the near-collapse of the municipal bond market. Other results include a scaling down of planned airport improvements in Los Angeles, an increase in three-shift classroom sessions in the schools of Dade

County, Fla., and fears of flooding in Clinton Township, Mich., because not enough storm sewers are being built. State and local governments spend roughly $26 billion a year to build schools, hospitals, roads, sewers, airports and the like, and last year they raised almost $11 billion of the sum by selling bonds. So far this year their bond sales are running 26% below that pace.

Almost $3 billion in bonds that would have financed public construction--including a new school for Hondo and a modern hospital for Iron County--have proved totally unmarketable. Probably a much greater total of bonds has not been scheduled for sale because local officials fear that they would find no buyers. Michigan voters, for example, last year approved two issues totaling $435 million to finance antipollution and park-building programs, but state authorities have never tried to set a date for investment-banking houses to bid on them. They have reason for their timidity. About half of the investment-banking houses that were buying state and city bonds a year ago, for resale to banks and rich individual investors, have stopped doing so.

The immediate cause of this chaos is the congressional drive to close tax loopholes. Interest paid on municipal bonds has always been exempt from federal income tax, but the reform bill that the House passed in August would make such interest partially taxable for many individual investors. Banks, which normally buy 70% to 80% of all municipal bonds, would continue to collect tax-free interest, but their officers fear that if the bill is finally enacted it will be only a matter of time before that exemption is limited, too. The slowdown in municipal-bond sales has produced something close to a revolt among governors, mayors and county officials. Several of them appeared before the Senate Finance Committee last week to denounce all proposals to tax municipal-bond interest.

Even Senate defeat of the tax proposal would not restore the municipal-bond market to health. That would require an easing of Washington's tight-money policy. Long before the tax debate boiled up, banks started curtailing purchases of municipals in order to conserve funds for loans to corporate clients. Municipal-bond prices dropped, and interest rates on outstanding bonds rose from an average of 4.85% in December to 6.37% in September. Laws in several states, notably Pennsylvania, Michigan, Florida and California, forbid payment of that much interest on new bonds. Those states, and their local-government units, have been unable to float new issues. Last week local governments failed to sell $142 million in public housing bonds paying 6% interest --even though they were backed by the credit of the Federal Government. Proceeds from the bonds were intended to complete several public-housing projects.

Legislatures are considering bills to raise permissible rates in several states, even though that is likely to lead to higher state or local taxes to pay the interest. If the bills pass, some local governments may have another try at selling bonds. Philadelphia school officials plan to offer a $60 million issue at 7% this month. They found no buyers at 6% in July for two issues of $30 million and $17.5 million. The money is needed for a program of closing and replacing 42 slum schools, all of which were built before 1907, and are not fireproof.

Too High a Price. As long as inflation forces the U.S. to restrict the money supply, states and cities will be at a disadvantage in competing against corporations for scarce investment funds. Some local governments may be able to increase taxes or find other ways to raise construction money. But most of the public facilities that were to have been financed by the unsuccessful bond issues probably will be long delayed, if not shelved entirely. That is part of the price that the U.S. must pay for having allowed inflation to rage unchecked for too long. The price, however, is being made unnecessarily high by the proposals to tax municipal-bond interest.

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