Attention Carbon Auditors: There is Low-Hanging Fruit in the Private Activity Bond Regulations

17 Pages Posted: 17 Jul 2010

See all articles by Darien Shanske

Darien Shanske

University of California, Davis - School of Law

Date Written: July 15, 2010


There are many ways in which the Internal Revenue Code doles out tax expenditures to non-sustainable development patterns. Most notably, there is the series of provisions that subsidize home ownership. These federal subsidies are in direct tension with the many programs meant to encourage denser, less energy-intensive, development patterns.

There is a more obscure federal tax subsidy given to energy-intensive (“sprawl”) pattern development, one that can be changed quickly and administratively, and which is the focus of this article – the regulations propagated around private activity bonds (“PABs”).

Local governments often work with private developers to issue bonds in order to build the backbone infrastructure for a new development, such as sewers and roads. In general, such bonds are used only when the new development is on unimproved land. This is because, as a general matter of state law, if bonds are to be issued secured by improved land, then the members of the existing community who live on that land will get to vote on the bonds. It is often difficult to get the required majority, especially in California, which often requires a supermajority. However, if there is only one (or a handful) of landowners, usually who own unimproved land, then the process is much simpler, and this much smaller group can vote to encumber their land, with the plan being that the bulk of the new assessments will be paid by new residents once the land is improved (in part thanks to the money raised by the promise of these assessments). It is a question of state law whether it should be made easier to finance new developments on unimproved land rather than encourage new infill pattern development. Federal tax law comes in because the bonds issued in such a scenario are currently tax exempt – that is the interest on the bonds is excluded from the income of the bondholders under Section 103, meaning that the bonds pay a lower interest rate than they would otherwise at the U.S. taxpayer’s expense.

Leaving aside the many good questions about the wisdom of the Section 103 federal tax exemption in general, the specific question considered by the Treasury in 1994 and 1997 was whether such bonds, secured by land that was to be improved, were “private activity bonds” and thus not eligible for the tax exemption under Section 103(b)(1). The prima facie case that they are private activity bonds is strong; they are issued on behalf of a private party (the developer) who then shares (or does not) the federal subsidy with other private parties (namely the new home buyers). The Treasury apparently reached the same conclusion that these bonds were private activity bonds when it first proposed private activity bond regulations in 1994.

However, in response to widespread criticism, especially from California, the Treasury backed down and allowed the kind of land-secured financing described above to retain its tax exemption. In so doing, the Treasury accepted the weaker (if plausible) argument even then, in 1997. However, now, in 2010, with our knowing far more about the externalities generated by this kind of development, the time has come for the Treasury to revisit its private activity bond regulations and go forward by going backward to its original 1994 proposal (at least in modified form).

Keywords: assessments, private activity bonds, land-secured finance, sprawl

Suggested Citation

Shanske, Darien, Attention Carbon Auditors: There is Low-Hanging Fruit in the Private Activity Bond Regulations (July 15, 2010). Tax Notes, Vol. 127, No. 693, 2010. Available at SSRN:

Darien Shanske (Contact Author)

University of California, Davis - School of Law ( email )

400 Mrak Hall Dr
Davis, CA CA 95616-5201

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