Guest post: Bring Back BABs

April 29, 2011

Jordan Eizenga of the Center for American Progress shares the following:

Infrastructure projects across the country are not going forward as planned. The culprit is a weak municipal bond market.

Extreme predictions of widespread default, a lack of bond insurance, and tight credit conditions have weakened demand for tax-exempt bonds and increased borrowing costs. This has prompted issuers to put off financing important infrastructure projects and municipal bond issuance is currently at an eleven-year low.

Today, The Center for American Progress’ Doing What Works Project has released a plan that will help stabilize the muni market, lower borrowing costs for issuers, and provide crucial support to state and local infrastructure projects.

Our plan calls on Congress to bring back the Build America Bonds program established under the 2009 Recovery Act and to place an annual cap on tax-exempt bonds.

Build America Bonds are taxable bonds issued by local governments in which the federal government covered a percentage of the interest costs. Despite its many successes, Congress let the program expire at the end of 2010.

Why do we propose this plan in particular?

First, a permanent Build America Bonds program would expand the municipal bond market to new investors such as pension funds that do not benefit from the tax exemption on traditional municipal bonds.

In creating new demand for municipal bonds, the bonds would lower borrowing costs and save issuers money. The U.S. Treasury Department estimated that state and local issuers saved $12 billion in net present value from issuing Build America Bonds during the life of the program.

And, if Build America Bonds are set at a revenue-neutral subsidy rate going forward, our plan could subsidize issuers without costing the federal government additional money.

Second, a revived Build America Bonds program and an annual cap on tax-exempt bonding, taken together, would allow Congress to better manage the size of the subsidy it provides for state and local finance.

At present, the subsidy delivered through the tax-exemption is determined mainly by marginal tax rates, as well as the aggregate volume and interest rates of tax-exempt bonds that state and local governments issue and have outstanding.

Our plan simply ensures that the federal subsidy is the product of deliberate policy decisions, rather than variables beyond the control of Congress. This is only fair if the subsidy is going to generate a cost to U.S. taxpayers.

To be sure, our goal is not to eliminate the tax-exemption on muni bonds by stealth. In fact, the tax-exempt market will benefit under our plan.  The return of Build America Bonds will relieve current supply pressures and cause yields to drop in the tax-exempt market as well (see chart).

And, of course, the cap on tax-exempt bonds would need to be set at a level that does not disturb the market in the short term. Dramatically and immediately reducing the availability of tax-exempt bonds could hurt issuers already face daunting fiscal challenges.

Yet, the fact remains that the current tax-exempt only bond market is not allowing state and local governments to affordably finance infrastructure projects.

Given the critical importance of infrastructure investment to our economy, something needs to be done and we hope that policymakers will give careful consideration to our proposal.

Jordan Eizenga is an Economic Policy Analyst at the Center for American Progress

Center for American Progress report

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