The BABs program allowed state and local governments to sell taxable bonds in 2009 and 2010 and receive a reimbursement (a “direct pay” option) from the federal government for a portion of the bonds’ interest costs.
While multiple bills were introduced in the House and Senate to extend the program, the last legislative vehicle in which Congress could have included BABs, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, did not include BABS or any of the other municipal bond provisions that were in the stimulus law, including the alternative-minimum tax (AMT) holiday or the extension of the $30 million small issuer limit for bank-qualified bonds.
The interest on BABs was taxable to investors. As a result, the nominal interest rate on BABs was about the same as interest paid by non-state and local government borrowers, such as corporations. BABs could not be used for re-fundings, working capital, private activities or 501(c)(3) organizations. BABs had helped the municipal securities market by providing a crucial new financing vehicle and a broadened investor base for state and local borrowers. BABs often had allowed state and local issuers to borrow at rates — net of the 35 percent interest reimbursement — that were a 0.5 to 0.6 percentage point or more lower than what they would receive in the tax-exempt market. BABs had saved states and localities and their taxpayers billions of dollars in interest costs and has generated numerous jobs.
Possibly the most important benefit of BABs was that they had opened up the municipal securities market to nontraditional investors, including pension funds, life insurance companies and foreign investors. These groups of investors purchased BABs because they were considered high-quality assets that allow diversification into an area of the credit markets that was not available to these investors in the past. Compared to the domestic tax-exempt bond market, the global market for taxable bonds is enormous. By giving states and localities access to this market at net borrowing costs that were comparable to or lower than rates in the tax-exempt market, BABs had helped assure a more stable source of demand for state and local debt.
In addition to broadening the buyer base for taxable financing, the BABs program had improved the under-capitalization of the tax-exempt market by decreasing the supply of tax-exempt bonds, thereby lowering borrowing costs in this market.
President Obama’s fiscal 2012 budget, which he released on February 14, 2011, proposes to permanently reinstate the Build America Bonds (BABs) program with a lower, revenue neutral, 28 percent subsidy rate. The BABs program, which were created by the American Recovery and Reinvestment Act of 2009 and expired on December 31, 2010, originally provided a 35 percent federal reimbursement of interest costs, but they could only be used for general obligation (GO) infrastructure projects. The president’s proposal would allow 501(c)(3) nonprofit issuers to sell BABs and expands their use to current refunding and short-term working capital. The House and Senate will consider the proposal and it is unclear whether BABs will be included in any budget to which Congress agrees.
SIFMA supported the permanent extension of the Build America Bonds program.
Extending the BABs program would have created certainty in both the taxable and tax-exempt markets and would have allowed for the most efficient and cost-effective means for state and local governments to finance critical infrastructure. Since the BABs subsidy is largely a substitution or alternative to the inefficient tax-exempt subsidy and less costly to the federal government than understood, it is an affordable enhancement to market efficiency and structure. A robust municipal bond market benefits not only issuers and investors, but also the restoration of the U.S. economy as a whole.