Virtually all publicly funded convention centers,
stadiums, arenas, and other infrastructure projects
are financed with debt instruments that are exempt
from federal income taxes, and often from state income
taxes if the investor resides in the state that issued
the bonds. Allowing investors in these bonds to earn
interest income that is exempt from federal income
taxes enables the municipalities to borrow at lower
interest rates.
By permitting communities to use tax-exempt
financing for "public purpose" investments
in this manner, the federal government, in effect,
provides a subsidy to the municipal bond issuer that
is equal to the federal income taxes that otherwise
would have been paid if the investor, say, owned
taxable bonds. As subsidies go, the federal tax
exemption on municipal debt is one of the most
inefficient because the loss in federal income tax
revenues is generally higher than the interest rate
savings to the municipality provided by the tax-exempt
status.
For a 30-year tax-exempt bond carrying an interest
rate that is two percentage points below a comparable
taxable bond rate, the present value of the federal
tax subsidy over the life of the bond is equal to
approximately 21 percent of the principal borrowed--or
$21 million for every $100 million of tax-exempt bonds
issued. For a typical $250 million ballpark being
constructed in many cities, this federal subsidy is
worth about $52.5 million, and for the Washington
Convention Center, the present value of the federal
tax subsidy could equal $110 million over the life of
the bonds.
Recognizing that the high costs and subsidies of
stadiums did not compare favorably to the benefits
they provide, compared with such other public
investments as schools, roads, and hospitals, Congress
in 1986 enacted legislation that eliminated the
ability of communities and sports team owners to use
tax-exempt financing to build stadiums. Specifically,
the Tax Reform Act of 1986 prohibits the use of
"private activity" tax-exempt bonds to
finance sports facilities, because the expanding use
of such bonds for that purpose was crowding out bonds
for other public purposes, providing greater tax
loopholes for the rich, and reducing federal tax
revenues.
Unfortunately, this attempted legislative remedy
backfired badly. Tax lawyers discovered that stadiums
could still use tax-exempt financing under another
provision of the U.S. tax code as long as no more than
10 percent of the funds used for debt service was
derived from the rental of the stadium--thereby
requiring that 90 percent of the funds be derived from
city and state taxes, or other non-rental fees.
Ironically, the use of this alternative provision
of the tax code bestowed even greater benefits on
sports team owners than the provision Congress had
rescinded. Under the former "private
activity" provision, rent and other revenues
derived from a stadium could be used to pay the
interest and principal on the bonds used to finance a
stadium. Communities had an incentive to offer
stadiums to team owners at rent levels that would at
least cover the debt service costs on the tax-exempt
bonds. But under the alternative provision of the tax
code that authorizes state and local governments to
issue tax-exempt bonds for public purposes, these
bonds are exempt from taxes only if no more than 10
percent of the debt service is derived from stadium
revenue sources. As a consequence, communities using
such bonds to finance a stadium or ballpark must find
alternative sources of tax revenues to service the
debt, since much of the rent that would be collected
could not be used to pay interest and principal on the
bonds.
Although the purpose of this requirement was to
ensure that only bona fide public facilities would be
eligible for the federal subsidy, in practice it has
induced communities to sign sweetheart deals with
sports team owners, because any direct rents derived
from the stadium could not exceed 10 percent of debt
service. In effect, under current federal law, had the
state of Maryland cut a tougher deal with Ravens owner
Art Modell for higher rent and revenue shares, it
might not have been able to use tax-exempt financing
to build the stadium. As a consequence of this
perverse interpretation of the law, communities
building sports stadiums must use tax revenues from
broad-based taxes--such as a hotel or restaurant tax
or an add-on to the sales tax--to pay off the loan for
the stadium. Because such taxes are paid by everybody,
and in most communities are part of general revenues
to be used for such services as schools and law
enforcement, the misuse of the federal tax code
ensures that stadiums will continue, as Modell
observed, to take precedence over libraries in many
communities.
Senator Daniel Moynihan's legislation (S. 1880)
would end this perverse misuse of the law by
classifying bonds issued to finance professional
sports facilities as "private activity"
bonds, thereby making them ineligible for tax-exempt
privileges. Sports team owners would have to finance
the construction of their own facilities, as is still
done in some communities, and this in turn would allow
local officials to focus on effective urban
revitalization strategies and free millions of dollars
in prospective public funds that could be redirected
to legitimate public purposes or tax relief.
CONCLUSION
The question of whether to subsidize a professional
sports facility is a contentious one wherever raised,
and in many cases the community, through referendum or
the decision of elected officials, chooses to go
forward with full or partial public support for the
facility. Unlike other forms of entertainment,
professional sports franchises create powerful
emotional bonds within the community that elevate the
aura of a team to "public good" and enable
easier access to public funds.
If a community's democratically determined
priorities endorse such spending, then few can argue
with it. But advocates of subsidized sports,
convention centers, and other forms of public
entertainment should be honest about what is at stake
and should not entice the public to believe they are
supporting broad-based economic development that will
contribute heavily to a city's economy. At the same
time, elected officials in declining cities, however
desperate they may be for new investment in their
communities, must realize that the revitalization
boost from such projects is negligible and that
community resources and civic energy would be better
directed to more productive activities.
As the record from around the country indicates,
the economic boost from public investment in
entertainment complexes is exceptionally modest at
best, and counterproductive at worst. It diverts
scarce resources and public attention from the less
glamorous activities that make more meaningful
contributions to the public's well-being.
--Ronald D. Utt is Grover M. Hermann Fellow in
Federal Budgetary Affairs at The Heritage Foundation.
