More than 10 years after the public unveiling of the arbitrage rebate requirement, municipalities and their consultants continue to struggle with both its administrative and economic implications.

The rebate requirement, which was imposed to curb perceived abuses of the federal interest cost subsidy, is designed to eliminate any incentive municipalities would otherwise have to: 1) issue more debt than necessary; 2) issue debt earlier than necessary; and 3) leave debt outstanding longer than necessary.

In its simplest terms, arbitrage profit is any income derived from investment of tax-exempt bond proceeds in excess of the potential earnings if such proceeds had been invested at the bonds' yield.

Federal tax law generally requires issuers of municipal debt to pay, or "rebate," any arbitrage profit to the Internal Revenue Service. Failure to comply with the requirement jeopardizes the tax-exempt status of interest on the bonds and typically constitutes a default.

As municipalities work to comply with rebate requirements, they can rely on in-house staff, hire outside consultants or combine elements of both options. The best choice depends on the circumstances, but the following, in order of priority, are key considerations:

* protecting bonds' tax-exempt status;

* paying the lowest legal amount;

* minimizing negative arbitrage; and

* minimizing compliance costs.

In order to protect the bonds' tax-exempt status, which determines as much as 50 percent of their value, issuers must make timely rebate payments of a reasonably determined amount.

"Timely" means no less frequently than the end of every fifth bond year, but more frequent calculations may be necessary to assure that adequate monies are set aside to make the required payments.

The reasonableness of any determination is a function of the calculator's qualifications to tackle that particular transaction. More difficult calculations, both in terms of mathematics and tax-law expertise, are those involving variable-rate bonds, refunding and refunded bonds and commingled investment accounts.

Generally, a free telephone consultation with bond counsel or a prospective rebate services provider can identify the probable level of difficulty of a particular issuer.

There can be several correct answers to a rebate calculation, all of which may be quite reasonable. The complexities of the applicable federal tax law allow for interpretation and expressly provide for optional elections and alternative investment allocations by municipalities.

The differences between costs based on two legally and otherwise correct analyses can run into the hundreds of thousands and even millions of dollars.

However, the best answer is usually not the easiest to obtain, so staffs or consults initially concluding that a payment is due may benefit from additional advice the assurance that they are not overpaying. More than 20 rebate-compliance providers now typically respond to open with fees averaging between $1,500 $2,500 per report.

On average, three or four analyses are required every five years. For these fees an issuer generally obtains a higher degree of comfort as to the previously discussed considerations, with little or no burden placed on existing staff resources.

What can be lost, however, is the staffs ability to integrate arbitrage rebate considerations into the municipality's overall financial strategy.

Consequently, an active staff working with a financial consultant can be an effective combination in the effort to comply with arbitrage requirements.