GULF BREEZE, Fla. - On U.S. 98, the crowded main drag that slices across Florida's Panhandle, it's easy to speed past Gulf Breeze. The city, which juts out into the blue waters of Pensacola Bay, is known for two things - its snowy white beaches and UFO sightings.
But Gulf Breeze, population 6,189, has another, less public claim to fame - it has floated about $2 billion in tax-free municipal bonds used in recent years to finance everything from a Hyatt Regency hotel in Orlando to sprawling convention and resort projects with casinos built by Baltimore-based Cordish Co. for the Seminole Tribe of Florida.
The bonds produced a bonanza in fees for the tiny community - $5 million since 1985. That's about $278,000 a year on average or 35 percent of Gulf Breeze's $14.2 million fiscal 2004 budget.
But now, Gulf Breeze and Moore Haven, another small Florida community that issued hundreds of millions in tax-free municipal securities, and the investors who bought them may be paying a price for their good fortune.
The Internal Revenue Service is questioning whether the Treasury was cheated out of millions in tax dollars from the Gulf Breeze and Moore Haven tax-free bonds. Now, the IRS wants the communities to get that money back for the government.
Among the issues being challenged by the IRS is $345 million in tax-exempt bonds issued by Gulf Breeze to finance the Seminole casino projects.
The IRS contends in documents released last week that the projects violate federal law because the bond money is being spent for private rather than public projects. The agency is also questioning the size of initial fees paid to Cordish and others who put the bond deal together.
Investors in tax-free municipal bonds don't pay federal income tax on the interest income they receive as the bonds are repaid. The tax savings make the bonds a more attractive investment and that lowers their cost to borrowers.
Gulf Breeze and Moore Haven have taken advantage of the popularity of these bonds by floating tax-free municipal bonds that have been used to finance projects around Florida and, occasionally, elsewhere.
That is perfectly legal if the bonds are used to finance construction that benefits the public, a definition that has been interpreted liberally in recent years to include everything from schools to hotels, apartments and racetracks.
But investigators for the state of Florida say some bond issues (called bond pools) sold by the two communities in anticipation of resale for use elsewhere were never used for public purposes. Instead, the bond money was invested to earn income, and the bonds profited only the communities, bond brokers and lawyers.
Such deals are at the heart of an IRS investigation, officials at the tax agency say.
"We are ramping up our efforts to look at abusive transactions," said Charles Anderson, the Baltimore-based manager of field operations for the IRS' tax-exempt bond office.
Gulf Breeze and Moore Haven officials insist they have broken no rules and say they have cooperated with the IRS and state investigators. Still, they say, they know some of their projects are being scrutinized.
Municipal officials are hopeful that they can convince the IRS that any problems with the bond issues they have floated are not their fault.
"We think we have a very good relationship with the IRS," said Edward M. Gray III, Gulf Breeze's former mayor and executive director of Capital Trust Agency, a bond issuer formed by the city and another nearby community.
Robert G. Harris, Moore Haven's vice mayor, complained that the bond issues have become "the subject of a witch hunt."
"Capitalism is viciously competitive. You start rubbing somebody else's rhubarb, they are going to find a way to go after you," he said.
Gulf Breeze and Moore Haven are in the bond business for a simple reason - to make money. The extra revenue helps them hold the line on taxes, build parks and buy fire engines, dump trucks and even playground equipment.
"We tend to have progressive and innovative approaches to providing for the citizens," said Gray. "The citizens love us."
Not everybody is enamored of Gulf Breeze and Moore Haven's bond business.
"It is out of control," said Michael R. Lissack, a former senior municipal investment banker at Smith Barney, who has turned whistleblower on what he sees as municipal bond abuses.
"They [Gulf Breeze and Moore Haven] discovered a way of earning revenue without having to do anything except by having a few fast-talking lawyers and bankers. By me, these bond deals constitute a fraud."
But issuing tax-exempt bonds to raise a pool of money is not unusual. Small cities often band together to raise money for projects instead of issuing bonds separately. This way, they can save on legal, consulting, underwriting and ratings fees.
What is unusual is when a city issues the bonds and the money is never spent for any public purpose.