ABSTRACT
This chapter explains the history and mechanics of arbitrage rebate and the calculations required for both the future value method and the penalty approach. As defined by the Department of Treasury Regulations, arbitrage is the gain a tax-exempt investor may be able to obtain by borrowing at a tax-exempt rate and investing at a taxable rate. Arbitrage rebate refers to the requirement to rebate to the federal government investment earnings derived with the proceeds of tax-exempt debt that are in excess of the earnings that would have been earned had the proceeds of the debt been invested at the same interest rate as that paid to the holders of the tax-exempt debt. The purpose of the Tax Reform Act of 1986 is "To eliminate significant arbitrage incentives to issue more bonds, to issue bonds earlier, and to leave bonds outstanding longer than necessary to carry out the governmental purposes of the tax exempt issue".
