WASHINGTON – The federal subsidy payments made to issuers of Build America Bonds and other direct-pay bonds will be cut by 6. 9% in fiscal 2017 under sequestration, the Internal Revenue Service recently announced.
The 6.9% cut, which will apply to subsidy payments processed on or after Oct. 1 of this year, is a slight tick up from this fiscal year's 6.8% cuts, which will end on Sept. 30.
The sequestration cuts are automatic, annual, across-the-board cuts for defense and nondefense programs which stem from Congress' failure to reach an agreement over how to significantly cut the deficit before March 2013.
The cuts apply to federal subsidy payments for, besides BABs, qualified school construction bonds, qualified zone academy bonds, new clean renewable energy bonds, and qualified energy conservation bonds.
For each of these types of bonds, issuers had the choice at one time or another to issue them in direct-pay mode rather than as tax-credit bonds. In direct-pay mode, the issuer gets subsidy payments from the Treasury Department or Internal Revenue Service that are typically based on a percentage of their interests costs.
The America Recovery and Reinvestment Act created BABs, allowing state and local governments that issued them in 2009 and 2010 to receive subsidy payments equal to 35% of their interest costs. The payments are to be made throughout the life of the bonds.
But sequestration cuts lowered the amounts of the subsidy payments. Some BABs have been redeemed because of sequestration through extraordinary redemption provisions in bond documents.
The 6.9% sequestration rate is much lower than in years previous to the current one. The rate was 7.3% in fiscal 2015, 7.2% in fiscal 2014 and 8.7% from March 1, 2013 through the end of that fiscal year. Historically, the rate depends on Medicare costs, based on the formula for determining the percentage rate of cuts each fiscal year.
The sequestration cuts have soured many issuers' interests in direct-pay bonds, even though some lawmakers and the president have proposed extending the BABs program at a lower subsidy rate.
"I think sequestration makes [direct-pay bonds] less attractive, said Matthias Edrich, a lawyer at Kutak Rock in Denver.
"It's become a hurdle," said Vicky Tsilas, a lawyer at Ballard Spahr and former Treasury official.
But Tsilas points out that the current administration supports more direct-pay bonds and said that Hillary Clinton, the Democratic president candidate, may follow suit.
In his fiscal 2017 budget request, President Obama called for the creation of a permanent program for state and local governments to issue America Fast Forward Bonds, which would be similar to BABS, but with a 28% subsidy rate and expanded uses. Obama would preclude the subsidy payments for these bonds from being subject to sequestration.
