Tax code constraints limit tribal tax-exempt bonding

Tax-exempt municipal¹ bonds play an important role in financing the construction of public purpose projects and supporting private development across the country. For a given level of risk, tax-exempt debt can offer a lower cost of capital than financing the same project using taxable debt.² Tribal governments, however, face both legal and debt service barriers to using this important financing mechanism available to state and local governments. These barriers can create challenges for tribes seeking to access the half-trillion-dollar annual tax-exempt municipal bond market for low-cost capital financing.

Tribal governments face both legal and debt service barriers to using this important financing mechanism available to state and local governments.

As part of our mission to advance the economic self-determination and prosperity of Native nations and Indigenous communities, the Center for Indian Country Development provides research and analysis on factors influencing access to capital in Native communities. To shed light on the barriers to tribes using tax-exempt bonding, we review the legal framework governing tribal tax-exempt bonding authority. We also provide an analysis of per capita tax-exempt bond financing. Our analysis spans 2003–2010—the most recent years for which both tribal-specific bond data are publicly available from the U.S. Department of the Treasury (Treasury) and annual municipal bond data are available from the Internal Revenue Service (IRS).

After accounting for differences in the target populations of both tribal governments and municipalities, we find that from 2003–2010, tribal governments’ use of tax-exempt bonds falls below that of state and local governments. We also explore tribal-specific factors that may explain why we observe this large capital gap. More tribal tax-exempt bond data are needed to extend this analysis to recent years.

Tribal governments’ disparate access to tax-exempt bonding dates back to the 1980s

Prior to 1983, federally recognized tribes (hereafter referred to as tribes) were not included as governmental entities eligible to issue tax-exempt bonds under Section 103 of the Internal Revenue Code (hereafter referred to simply as tax code). However, in 1983, Congress passed the Indian Tribal Governmental Tax Status Act, authorizing tribes to temporarily issue tax-exempt bonds under a newly added Section 7871. While many of the provisions were set to sunset in 1985, this tribal authority was later made permanent in 1984. Despite the act’s initial purpose of creating tax parity between tribal and state governments, tribal organizations have questioned the act’s final text for failing to establish tax parity between tribal governments and other governments.

Section 7871 imposes two substantial restrictions on tribal tax-exempt bonding authority inapplicable to state and local governments: (1) tribal governments cannot issue tax-exempt qualified private activity bonds, with one narrow exception;³ and (2) substantially all tribal governmental bond proceeds must finance an “essential government function.” The qualified private activity bond restriction renders tribes ineligible to issue exempt facility bonds (the proceeds of which can be used to finance solid waste disposal and waste recycling facilities), small issue bonds (the proceeds of which can be used for manufacturing facilities and farm property), and redevelopment bonds (the proceeds of which can be used to improve blighted areas).⁴

This departure in interpretation of “essential government function” restricts the class of tribal projects eligible for tax-exempt financing while simultaneously maintaining the broad scope of the state income tax exemption.

The rationale for the “essential government function” restriction on tribal governmental bonding authority is explained in a 1982 Senate Finance Committee report often cited by the IRS. As articulated in this report, “These provisions do not permit an Indian tribal government (or subdivision) to issue tax-exempt bonds under circumstances where a corresponding issue by a State (or political subdivision) would not be tax-exempt.”

In other words, the law prevented tribes from exploiting two tax exemptions—tax exemptions associated with bond financing as well as federal and state tax exemptions for project income—for a single project unless states could also do the same. To achieve tribal tax-exemption parity with states, Congress included the “essential government function” language appearing in Section 115 of the tax code. Section 115 exempts income derived from utilities or exercises of any “essential government function” performed by state and local governments from taxable gross income. In this way, Congress…