WASHINGTON – Tax credit bonds could be an attractive alternative to municipal bonds during sluggish or uncertain economic periods, according to the Congressional Research Service.
A 17-page report, released Tuesday by CRS, analyzed the current and future standing of TCBs, the main alternative to tax-exempt bonds that are used to finance public and certain qualified private projects. The report accounted for the expiration in recent years of state and local governments' ability to issue several types of TCBs.
TCBs, which provide a tax credit or direct payment to the issuer that is proportional to the bond's face value, have mainly been established as temporary tax provisions. Unlike municipal bonds, which do not create a taxable income stream, TCB credit amounts are included in the bondholder's gross income and are taxable.
The TCB credit is dependent on both the interest rate of the bond and its credit rate set by the Treasury Department. Because TCBs aren't intended to be sold at discount, the value of TCBs compared with corporate bonds is less dependent on general economic conditions than munis.
"Therefore, TCBs may be relatively more attractive compared to municipal bonds in economic periods of low growth or great uncertainty," analysts said in the report.
Under normal economic conditions, munis are offered at a lower interest rate than that of corporate bonds, but CRS said the interest rate gap was much narrower between early 2011 and 2015, and, in some cases during that period, munis' rates were higher than those of corporate bonds. This was due in part to fallout from the Great Recession as well as concerns about the potential and actual defaults by municipalities including Chicago and Puerto Rico, the analysts said.
By 2015, the rates between munis and corporate bonds returned to normal, which CRS analysts said could have been due to anticipated interest rate increases by the Federal Reserve. Though munis are anticipated to perform better as interest rates increase, the report said the recent fluctuations make it difficult to predict the rate spread going forward.
Emily Brock, director of the Government Finance Officers Association's federal liaison center, said the group continues to maintain its support for the partnership between the federal government and issuers on the tax-exempt standing of munis.
Despite the findings of the CRS report, Brock said that munis continue to perform well.
"GFOA continues to maintain that the municipal market is strong and has responded positively to municipal securities, while this hasn't been traditionally the case for TCBs," Brock said.
Build America Bonds (BAB), created under The American Recovery and Reinvestment Act of 2009, are a direct payment TCB and offer a credit amount equal to 35% of the interest rate established by the buyer and issuer.
In their report, CRS analysts cited a Treasury Department report that estimated BABs saved issuers roughly $20 billion in interest costs through December 2010. Created to reduce borrowing costs for issuers, a total of $181 billion of BABs were issued before they expired at the end of 2010.
Current legislation, including the Build America Bonds Act of 2015 (H.R. 2676) and the Bolstering Our Nation's Deficient Structures Act of 2015 (S. 1515) would reauthorize and extend the issuance of BABs indefinitely.
Under both bills, the credit rate for BABs would decrease to 28% for bonds issued in 2019 or later from 35% for bonds issued in 2009 or 2010. The House bill, introduced in June 2015 by Rep. Richard Neal, D-Mass., was referred to the House Ways and Means Committee, while the Senate bill, introduced in the same month by Sen. Edward Markey, D-Mass., was referred to the Senate Finance Committee.
In her proposed tax plan, Democratic presidential nominee Hillary Clinton also proposed renewing and expanding BABs under a program to be administered in part by a national infrastructure bank.
President Obama's fiscal 2017 budget included several TCB proposals, including the creation a new TCB for certain infrastructure programs.
The report's analysts said that proposals to reduce the issuer credit rate to 25% or 28% would increase the likelihood that issuers would opt instead for tax-exempt bonds.
Other TCBs created under ARRA included Qualified School Construction Bonds as well as Recovery Zone Economic Development Bonds, which are taxable and include a tax payment to the issuer. Qualified Zone Academy Bonds, used to finance public school programs in economically struggling areas, were extended with $400 million of capacity for 2015 and 2016 under the Consolidated Appropriations Act of 2016.
