WASHINGTON — Senate Finance Committee chairman Max Baucus wants Congress to consider alternatives to tax-exempt bonds in order to provide uniform subsidies for bondholders, and cites Build America Bonds as a good example.

“Tax-exempt bonds subsidize interest paid on such bonds by exempting the interest rate from tax. Currently, the value of this subsidy varies based on taxpayers’ marginal income tax rates,” the Montana Democrat said during a hearing Wednesday on tax reform and state and local tax policies.

“For every dollar we spend on infrastructure through a tax-exempt bond, 20 cents goes to tax breaks for higher-income taxpayers. A uniform subsidy would mean each taxpayer receives the same subsidy regardless of tax bracket,” he said.

Baucus cited taxable BABs as a program that “achieved success using this approach.” However, BABs provide uniform subsidies to issuers, not bondholders, sources said.

Under the BAB program, which was created in 2009 by the American Recovery and Reinvestment Act and expired at the end of 2010, issuers sold more than $181 billion of BABs and received subsidy payments from the federal government equal to 35% of their interest costs. President Obama has proposed reinstating the program at lower subsidy rates.

Tax-credit bonds are the only type of bonds that provide investors with uniform subsidies. The bondholders receive tax credits from taxable bonds, but Baucus never mentioned them. He talked about a successful BAB financing in Montana.

Baucus’ remarks, instead, seemed to refer to the claim by some economists that tax-exempt bonds are an inefficient mechanism for the federal government to transfer funds to state and local governments.

Frank Sammartino, the Congressional Budget Office’s assistant director for tax analysis, noted this in his written testimony, which he summarized.

“Several analysts suggest that about 80% of the tax expenditures from tax-exempt bonds translates into lower borrowing costs for states and localities, with the remaining 20% taking the form of a federal transfer to bondholders in higher tax brackets,” he wrote. “In contrast, for tax-credit bonds, the revenues forgone by the federal government are captured entirely by state and local governments” and, with BABs, “a direct appropriation of funds to state and local governments would subsidize more spending per dollar of impact on the federal budget.”

But tax-credit bonds have not been welcomed by the market in part because of their limited size and the absence of rules allowing the tax credits to be stripped and sold separately from the bonds, he said.

Committee member Sen. Maria Cantwell, D-Wash., told colleagues she would oppose any proposal to limit tax-exempt bonds that would disadvantage public power.

The interest on tax-exempt bonds totals about $50 billion per year, Baucus said.

At the end of 2011, state and local governments owed roughly $3 trillion in tax-exempt, tax-credit and direct-pay bonds, Sammartino said.

Meanwhile, the National Governors Association provided written testimony to the committee that warned against eliminating or curbing tax-exempt bonds.

“No effective substitute for tax-exempt bonds exists,” the NGA said. “Investor demand for alternatives like tax-credit bonds is insufficient at best. Taxable direct subsidy bonds permitted for issue during 2009 and 2010 only complemented tax-exempt bonds, but only when the taxable bonds provided a subsidy far greater than the benefit to investors from interest deductibility.”

“If municipal bond interest were taxable, or if the federal tax-exempt status on state and local bonds were capped or lifted, the cost of borrowing, and therefore of financing infrastructure, would rise for states. Ultimately, this cost would be borne by taxpayers through reduced infrastructure spending, higher taxes or both,” the group said.

Baucus also bemoaned the fact that 142 temporary tax provisions exist, some of which are muni-related. “I’m going to push hard [for people] to deal with these provisions: make them permanent or repeal them,” he said.

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