Washington — In 1936 no one made stockings in Durant, Miss. But the legislators at the capital in Jackson knew something had to be done. The state's agriculturally based economy was creeping along like a cart with square wheels. Cotton was not enough; Mississippi needed industry. So, in a burst of ingenuity, the politicians passed a bill permitting cities and towns to finance manufacturing facilities by issuing tax-free bonds. Once built, the factories would be leased to private industry.
That year the tiny town of Durant floated the first such bond, for $85,000, to build a factory for Realsilk Hosiery Mills. By 1980, 47 states put out more than $8 billion worth of these small-issue industrial revenue bonds. And now, the first extensive study of the so-called IRBs, undertaken by the Congressional Budget Office, has raised a difficult question: When does the financing of private enterprise serve the public good?
IRBs are paid off by the enterprises that benefit from them. But since they're tax-free, these enterprises save money because they can offer below-market interest rates --usually about two-thirds of the prime rate -- and still attract buyers. The cost to taxpayers comes indirectly, in the form of lost tax revenues.
Originally, the bonds were intended to lure new industry into depressed areas. But over the years, IRBs have been used more and more for commercial and service purposes.
In 1968, Congress became concerned that large, cash-flush corporations were cutting their costs with IRBs. Legislation was passed limiting large IRBs to semipublic services, such as airports or pollution control.
But IRBs under $1 million (since raised to $10 million) were left uncontrolled. States could issue them as they pleased.
Their use exploded. In 1975, small-issue sales were about $1.3 billion. By 1980, the figure was $8.4 billion. It is these "small issue" IRBs that are now coming under scrutiny.
In the last decade, small IRBs have helped build 32 McDonald's outlets in Pennsylvania and Ohio, financed 35 K mart discount stores, and been used to construct everything from dentists' offices to golf courses. In one highly publicized abuse, a $400,000 IRB helped an investor purchase an "adult" bookstore in Philadelphia. Critics say these uses benefit private business at the expense of the public and that the projects would have been built anyway, even if IRBs weren't available.
Others claim critics simply seize the interesting abuses and wave them about, like a flag, while ignoring the good that IRBs can do.
"The so-called abuses are always the same ones," says Robert Patterson, executive director of the Massachusetts Industrial Finance Agency.
The Congressional Budget Office estimates the government's revenue loss on IRBs will amount to about $1 billion in fiscal year 1981, rising to between $2.9 billion and $4.4 billion in fiscal year 1986.
But that whopping figure doesn't tell the whole story. The IRBs generate jobs and sales which are taxed, creating a revenue "reflow." When "reflow" is included in the equation, the CBO estimates that eliminating these bonds would gain the federal government $200 million in tax dollars in 1982, and $700 million by 1986.
A competing study, by Roger Kormendi, a University of Chicago economist, estimates initial revenue losses at only one-sixth the size of the CBO's -- and he says that "reflow" is enough to give IRBs a net positive effect on the tax rolls.
Concerned about revenue losses and the changing use pattern of the bonds, a House Ways and Means subcommittee is eyeing IRBs to see if they need a little more restriction.
IRBs might be directed toward small companies or distressed areas. Their use could be restricted to manufacturing projects, or states could have limits on how much IRB money they could issue.
The CBO chief, Dr. Alice Rivlin, testifying before the committee, estimated that 15 percent of the dollar volume of small IRBs is still going to large corporations, and that 20 to 25 percent is being used for retail establishments.
"Clearly, there is a competition for capital here," she said when asked about possible regulation of the bonds. "But it's a very hard line to draw. Some of these projects might not be profitable at higher interest rates."
Rep. Charles B. Rangel (D) of New York, chairman of the subcommittee which has jurisdiction over the bonds, is reportedly leaning toward more restrictions. The Treasury Department, which stands to gain from cutting IRB use, has not yet taken an official position.
John Chapoton, assistant Treasury secretary for tax policy, testified that no position would be taken pending action on the President's economic program. He did maintain that IRBs "effectively raise the cost of traditional public works" by raising the cost of borrowing money, but also said any action taken should not "discriminate against any specific area of the country."
The Northeastern states are heavy users of IRBs, often for construction in economically depressed areas.
"We try to use it to target investment in the cities," says Robert Patterson of the Massachusetts Industrial Finance Agency. "If they take this away, the relative benefit we can offer for downtown over suburbia will disappear."
IRBs have played a key role in renovating such time-worn city centers as Lowell, Mr. Patterson said.
Others claim IRBs are worth every penny, and that restricting them further would be throwing the baby out with the budget cuts.
"It has meant more jobs," said Mississippi Gov. William Winter, describing the effect of IRB financing on his state. " It has meant the creation of wealth."