The congressional Joint Tax Committee has estimated that President Obama’s fiscal 2012 budget proposal to permanently reinstate Build America Bonds at a 28% subsidy rate would result in net revenue losses of $5.7 billion to the federal government over a 10-year period.
The figure takes into account almost $76.3 billion of subsidy payments the federal government is projected to make to issuers of BABs during those years.
The committee included the estimates in a report entitled “Description of Revenue Provisions Contained in the President’s Fiscal Year 2012 Budget Proposal” that it released earlier this week.
The Obama administration’s proposal also would expand the use of BABs to include working capital and projects for 501(c)(3) nonprofit entities as well as capital projects and would allow current refundings of BABs.
In current refundings, the previously issued bonds are retired within 90 days of the issuance of the refunding bonds.
In its analysis of the BAB program — which was created by the American Recovery and Reinvestment Act in early 2009 but expired at the end of 2010 — the committee noted that $181 billion of BABs were sold by issuers in all 50 states, the District of Columbia, and two territories.
“Initially, issuers of long-term BABs obtained financing, after the application of the federal subsidy, which was significantly less expensive than comparable tax-exempt debt,” the Joint Tax Committee said.
For example, California issued 30-year BABs at an interest rate of 7.4%, but only had to pay net interest of 4.8% after taking into account the federal subsidy, which equaled 35% of interest costs.
“Over time, as the market for state and local debt adjusted to the new instrument, BABs’ net interest rates and tax-exempt bond interest rates began to converge” as the tax-exempt rates began to fall, the committee said.
One reason for the fall in tax-exempt rates was that the increased issuance of Build America Bonds reduced the available supply of tax-exempts, resulting in higher prices and lower interest rates for the bonds.
“Therefore, a secondary effect of the BAB program is that some of the benefit that used to accrue to the investor in tax-exempt bonds now accrues to the state and local government in the form of lower tax-exempt bond interest rates,” the committee said.
Republicans have opposed reinstating the BAB program, claiming it encouraged states with lower credit to issue the bonds for higher subsidies and provided underwriters with lucrative fees.
But the panel’s report, which was bipartisan and presented all of the various views about BABs, suggested an argument could be made that a permanent BAB program would strengthen the market for the bonds and permit them to be issued at lower interest rates with lower associated fees.
The Joint Tax Committee’s report noted that some lawmakers may be concerned about a permanent BAB program’s effect on the federal deficit because Washington is obligated to subsidize the bonds as long as they are outstanding, typically for 20 or 30 years.
“Unlike spending programs that are generally part of an annual appropriations process, the outlays for the BAB program are treated as tax refunds, which are outside the annual appropriations process,” the report said.
The panel said that while the 35% federal subsidy for BABs is significantly “deeper” than that provided by tax-exempt debt, a 28% subsidy also would be deeper than that for comparable tax-exempt debt for at least some projects — particularly, long-term debt.
Using several assumptions that it did not detail, and warning its forecasting on the relationship between BABs and tax-exempts is speculative, the committee projected that an after-subsidy yield on BABs with a 28% subsidy rate would be 4.45%.
Between 2000 and 2007, the interest rate on municipal bonds was on average 79% of the interest rate on comparable corporate debt, according to the report.
“Assuming a similar relationship in the future implies tax-exempt interest rates of 4.89%, which suggests that BABs provide an interest cost savings of approximately 9% over tax-exempt bonds,” the committee report said.