EPA Sees Problem In Proposed Reg's Definition Of Sewage Facilities.

Michael B. Cook of the Office of Wastewater Management, Environmental Protection Agency (EPA), Washington, has expressed concern regarding proposed reg. section 1.142(a)(5)-1's definition of the term "sewage facilities" for the purpose of clarifying the eligibility for tax exemption of certain private activity bonds. According to Cook, the EPA believes that the proposed definition "will have the unintended effect of denying tax-exempt financing for some public-purpose wastewater treatment facilities that perform essential municipal services."

The problems with the proposed reg, Cook says, arise primarily from its reliance on what the Service states in the preamble are ". . . operations historically performed at most publicly owned treatment works. . . ." He asserts that the continuing changes in the regulatory, technological, and financial factors affecting municipal sewage management make that an inappropriate benchmark. In his comments, Cook outlines under specific categories the problems that the EPA foresees with the regulation. He notes that although the EPA isn't able at this time to suggest precise alternatives to the provision of the proposed reg, it offers its technical assistance to the Service as it reviews the comments it receives.

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CC:DOM:CORP:T:R (PS-34-93)

COMMENTS OF THE OFFICE OF WASTEWATER MANAGEMENT

The Office of Wastewater Management (OWM) administers the municipal and industrial wastewater control programs of the U.S. Environmental Protection Agency (EPA) under the authority of the Federal Water Pollution Control Act, as amended (commonly known as the "Clean Water Act" (CWA)). These programs include the National Pollutant Discharge Elimination System (NPDES), the industrial pretreatment program, the construction grant program, and the State Revolving Fund (SRF) program. The Office's activities cover all aspects of wastewater management, including collection, treatment, sludge disposal, wastewater reuse, pollution prevention, combined sewer overflow control, and storm water management.

These comments reflect the concerns of OWM and its counterpart offices in EPA's ten Regions regarding Proposed Regulation Section 1.142(a)(5)-1 (the "proposed regulation"), defining the term "sewage facilities" for the purpose of clarifying the eligibility for tax exemption of certain private activity bonds (PABs). We are pleased that the Internal Revenue Service (IRS) has undertaken to establish an understandable and workable definition of the term. This effort ultimately should eliminate the substantial confusion that recently has surrounded attempts to issue exempt facility private activity bonds for various facilities.

However, we believe that the definition proposed by IRS will have the unintended effect of denying tax-exempt financing for some public-purpose wastewater treatment facilities that perform essential municipal services. The problems with the proposed regulation primarily arise from its reliance on what the IRS in the preamble states are ". . . operations historically performed at most publicly- owned treatment works. . . ." Unfortunately, current and continuing changes in the regulatory, technological, and financial parameters surrounding municipal sewage management make this an inappropriate benchmark. The problems that we foresee are outlined below under specific categories. We recognize that the proposed regulation only applies to PABs; our comments on the proposed definition relative to the general nature of municipal sewage treatment are needed for context for our comments regarding the potential impact of the proposed regulation on financing wastewater infrastructure.

REGULATORY AND TECHNOLOGICAL ISSUES

LEVEL OF TREATMENT

The proposed regulation implicitly assumes that publicly-owned treatment works (POTWs), which the IRS appears to accept as "traditional" sewage facilities, are intended only to provide secondary treatment of influent with an average daily raw waste load concentration of biochemical oxygen demand (BOD) of 350 milligrams per liter or less as oxygen. However, secondary treatment is the statutory baseline technology for POTWs. The CWA mandates additional treatment of wastewater in many cases in order to achieve water quality standards. The techniques used to accomplish this additional treatment are those explicitly excluded from the proposed definition of sewage facilities: extended secondary treatment, advanced treatment, and tertiary treatment. The following background and example illustrate this point.

Municipalities with sewage treatment plants discharging into waters of the United States must obtain a National Pollution Discharge Elimination System (NPDES) permit with limitations on the allowable quality and quantity of waste discharge. The minimum limit is set at secondary treatment -- generally a 30-day average of BOD and suspended solids of 30 mg/l and a 30-day average removal of BOD and suspended solids of not less than 85 percent. However, depending upon receiving stream water quality conditions, more stringent limits may be set. Therefore, while one municipality may be required to meet secondary treatment, another may be required to provide tertiary treatment, even if they both have the same influent wastewater characteristics. The proposed definition does not take into account what a sewage treatment facility is precluded from discharging.

For example, domestic sewage normally contains the nutrients phosphorus (10 mg/l) and nitrogen (20 to 40 mg/1) with NO contribution of any kind from industry. Domestic sewage treatment facilities in the Great Lakes basin are generally precluded from discharging more than 1 mg/l of phosphorus and are frequently required to remove nitrogen, in one or more chemical forms, from the wastewater being discharged, both in order to meet water quality standards. Phosphorus is removed most often by the addition of a metallic salt, usually alum or iron sulfate, to flocculate and precipitate the phosphorus prior to discharge. Nitrogen is usually removed by extended aeration in biological treatment systems. Additionally, normal domestic sewage treatment facilities must sometimes add treatment by tertiary filtration (sand filters) to remove excess suspended solids. These same requirements apply nationwide for discharge to lakes, drinking water sources and high quality resource waters.

The National Pretreatment Report to Congress submitted by EPA in July 1991 provides data showing the extent to which POTWs are required to provide treatment beyond the secondary level. The report states that 39.6 percent of "pretreatment POTWs" were permitted for greater than secondary treatment. Pretreatment POTWs are those that receive substantial influent from industrial dischargers. These "indirect dischargers" are required to remove from their waste flow any pollutants that the POTWs are not capable of treating or that would damage the treatment process(es).

More significantly, the report shows that 22.3 percent of nonpretreatment POTWs also are permitted for greater than secondary treatment. These are facilities that receive no substantial industrial flows. They typically are required to provide more extensive treatment because of the quality of the waters into which they discharge rather than the quality of the flows into the system. We do not believe these are the type of facilities the IRS intended to proscribe from the universe of sewage facilities.

BOD Limit

The provision in the proposed regulation limiting the portion of secondary treatment deemed to be part of a sewage facility to that which is needed to treat wastewater having an average daily raw waste load concentration of biochemical oxygen demand (BOD) of 350 milligrams per liter or less as oxygen generates a difficulty for municipal wastewater treatment that contradicts Federal environmental policy. The EPA is stressing "pollution prevention" in order to reduce the amount of waste the Nation must treat. An important element of our pollution prevention program is "water use efficiency." This effort is succeeding in reducing residential, commercial, and industrial consumption of water. In fact, the Federal government recently set new plumbing standards to ensure the use of low-flow fixtures in new construction. As the VOLUME of wastewater decreases, however, it is not anticipated that domestic pollutant LOADS will decrease. Therefore, the CONCENTRATION of pollutants such as BOD will increase.

The IRS has admirably attempted, and perhaps succeeded, in establishing a BOD limit that reasonably approximates the current upper limit for most POTWs. But there are critical exceptions in small communities. Also, the limit is inconsistent with the Administration's pollution prevention priorities and creates a disincentive for communities to pursue water conservation.

TOXIC POLLUTANTS

The proposed regulation excludes from the definition of sewage facilities those that treat toxic, priority, and nonconventional pollutants. The IRS is correct in asserting that these pollutants are not "ordinarily" treated at POTWs. Once again, however, there are significant exceptions that the proposed regulation should accommodate. Not all such pollutants are discharged to POTWs by identifiable industrial sources. Disposal "down the drain" of chemicals by residential and diverse commercial users of municipal sewage systems can create significant if not major loads. POTWs already struggle to deal with this problem and their task should not be further complicated by the potential loss of tax-exempt financing as a source of funds to install the necessary technology. Perhaps in this instance a limit well below industrial concentrations can be established by the IRS with EPA's assistance.

WATER REUSE AND WATER RECLAMATION

The EPA believes that water conservation measures such as reclamation and reuse of wastewater effluent is integral both to pollution control and water supply. The proposed regulation hinders implementation of such measures through its exclusion in Section 1.142(c) of ". . . property used to treat, process, or use wastewater subsequent to the time the wastewater can be discharged into navigable waters. . . ."

The State of Kansas provided to EPA a good example of the problem in its description of the wastewater treatment facility in the City of Hays:

A great portion of the facility upgrade was driven by water

This matter is especially important in the arid West, where wastewater reclamation and reuse decreases discharges into sensitive, low-flow, surface waters and provides critical augmentation of scarce water supplies. Municipal water reclamation and reuse projects are in particular danger of being adversely affected by the proposed regulation because they often include private partners as operators of the system and/or as users of the reclaimed wastewater.

FINANCIAL ISSUES

PUBLIC-PRIVATE PARTNERSHIPS

The EPA over the past few years has attempted to understand and influence the funding of environmental infrastructure such as municipal wastewater treatment beyond the assistance programs the Agency has managed. Budget difficulties and scarce resources at the Federal and state level are reducing capital subsidies to municipalities. Local government, which has always provided the bulk of the funds for wastewater treatment, is becoming more financially responsible for the capital improvements necessary to achieve the objectives of the CWA. Tax-exempt financing of these facilities is crucial to communities' efforts in this regard.

We understand that currently most municipal wastewater facilities are owned by a political subdivision of public status and therefore are able to use the proceeds of "governmental use" tax- exempt bonds. The proposed regulation would not apply to such bonds. However, this simple distinction ignores the fact that communities increasingly are creating public-private partnerships for the financing, construction, and operation of infrastructure facilities, including sewage facilities. This trend is recognized and supported, in fact, by "President Clinton's Clean Water Initiative," which presents recommendations for reauthorization of the CWA. The Initiative proposes a definition of POTW that would ensure that all public-purpose wastewater facilities -- public, public-private, and fully private -- are regulated equitably based on what they do and who they serve rather ownership.

Many of these partnerships are able to make use of qualified exempt facility PABs. Under the proposed regulation the financing of many aspects of an integrated municipal wastewater treatment system benefiting from a public-private partnership would no longer qualify as an exempt sewage facility. This presents a particularly acute problem because of the nature of the partnerships that are being created.

It is often the need for more complex treatment technologies that leads communities to turn to the private sector for assistance in meeting their responsibilities under the CWA. A private firm can develop the technology and expertise necessary to effectively operate advanced treatment technologies better than can a city with one plant. To the extent that the private entity jointly owns, or operates under a long-term management contract, the technology installed in the sewage facility and the bonds issued to finance the upgrade or improvement are deemed to be PABs, the proposed regulation would prevent the bonds from being qualified exempt facility bonds. In cases of full "privatization," whereby a municipality is served by an investor-owned wastewater utility, ANY bond-financed capital improvements would be subject to the proposed regulation and, as described above in our technological and regulatory comments, most upgrades to technology would fail to be qualified facilities.

The EPA believes that local officials are in the best position to develop capital financing structures that help them to meet their wastewater treatment needs. We find that communities throughout the Nation are taking the lead in "reinventing government" and acknowledging the ability of private capital to enhance public investment. Just as EPA acknowledges these local initiatives in recommending changes to the regulatory treatment of public-private partnerships, the IRS in its final proposed definition of sewage facilities should recognize these changes to the financing of "traditional" POTWs.

STATE REVOLVING FUND PROGRAM

The State Revolving Fund (SRF) program is the major Federal financial assistance program for municipal wastewater treatment. The EPA provides capitalization grants to the states, which in turn provide low-interest rate loans to municipalities. The states are authorized to "leverage" the Federal capitalization grants rather than provide direct loans. Eighteen states currently do so. In leveraging an SRF, a state typically uses the EPA grant funds to secure the issuance of state tax-exempt bonds. The SRF loans the bond proceeds to municipalities and uses interest earnings on the Federal funds to subsidize the interest paid on the loans.

We believe that the proposed regulation has little immediate, direct impact on the SRF program. The state debt obligations issued so far clearly have been for "governmental use" and not subject to PAB rules. At least one state, however, had to restructure its leveraged SRF in order to provide assistance to a community from grant funds rather than bond proceeds because of the danger that the proceeds' use as a loan would cause the issue to become PABs. As we have noted extensively above, technological and financial changes to municipal wastewater treatment are occurring that likely will cause this to be a more common problem.

Our comments in reference to financing under public-private partnership apply to the SRF program to the extent that such financing is made by SRFs through bond proceeds. The problem is exacerbated by the fact that leveraged SRFs are pooled financing. The tax-exempt status of the pools, or at least that of any segmented qualified exempt facility PAB portion, would be endangered if one facility ran afoul of the proposed regulation.

CONCLUSION

The EPA offers these comments to Proposed Regulation Section 1.142(a)(5)-1 in an effort to assist the IRS is developing an understandable, workable definition of "sewage facilities" for purposes of determining qualified exempt facility PABs. Our fundamental concern is that the definition in any final regulation recognize not only the "historical" function and financing of municipal sewage facilities, but also the changing nature of wastewater management. While we are not able to articulate precise alternatives to the provisions of the proposed regulation at this time, we do offer our continuing technical assistance to the IRS as it reviews and responds to comments it receives. We would be pleased to clarify our comments and to work with the IRS and other interested and affected parties to ensure an effective definition of sewage facilities.

Dated: July 5, 1994

Signed: Michael B. Cook, Director