WASHINGTON — Senate Finance Committee chairman Orrin Hatch has rebuffed the idea that his tax bill would fall under the Pay-As-You-Go Act of 2010 and trigger billions of dollars in across-the-board spending cuts in Medicare and other federal mandatory programs, zeroing out subsidy payments for direct-pay bonds.

Senate Finance Committee Chairman Orrin Hatch, R-Utah
Senate Finance Committee Chairman Orrin Hatch, R-Utah Bloomberg News

“My colleagues are trying very hard to link tax reform to cuts to Medicare by referencing statutory PAYGO rules,” Hatch, R-Utah, said on Wednesday, referring to Democrats who had raised concerns during the committee’s consideration of the tax bill.

“There hasn’t been a single sequester ordered under the PAYGO statute,” Hatch said. “Congress routinely exempts spending and revenue measures from the PAYGO scorecards. Since the PAYGO statute was enacted seven years ago, 16 laws with estimated budgetary effects on direct spending and revenues included provisions to exclude all or part of the law. Most of those exclusions took place while the Democrats controlled the Senate. So, let’s not try to claim that the legislation we’re debating will surely lead to a Medicare sequestration, because, so far, no law has.”

But budget experts said the pending tax bills do not currently waive the PAYGO requirements and that if Hatch’s bill passes the committee and moves to the Senate floor, a Democrat or other Senator could raise a point of order stating the bill is subject to the PAYGO Act. The chair of the Senate, with advice from the Parliamentarian, would rule on whether the point of order is “well-taken” or not. After the chair rules, a Senator may ask for a vote on the ruling. Sixty votes would be required in the Senate -- more than a simple majority -- to approve or overturn the chair’s ruling.

Asked if he might raise a point of order, Sen. Ron Wyden, R-Ore., the top Democrat on the Senate Finance Committee told The Bond Buyer that it depends on the tax bill approved by the committee.

The remarks by Hatch and Wyden came after The Bond Buyer published a story stating the tax bills pending in the House and Senate could eliminate billions of dollars of Treasury Department subsidy payments to issuers of Build America Bonds and other direct-pay bonds because of the PAYGO Act, which was enacted in 2010.

The story echoed a letter the Congressional Budget Office sent Tuesday to Minority Whip Steny Hoyer, D-Md. about the impact of a bill adding $1.5 trillion to the deficit over the 2018-2027 period. The tax bill pending in the House would add $1.5 trillion to the deficit over that 10-year period. The tax bill in the Senate was modified late Tuesday by Hatch but would still add $1.4 trillion to the deficit, according to the Joint Committee on Taxation.

CBO Director Keith Hall told Hoyer in the letter that, because of the PAYGO Act, a deficit of that size could force the Office of Management and Budget to issue a sequestration order to cut billions of dollars from mandatory federal programs.

Bill Daly, director of governmental affair at the National Association of Bond Lawyers and others said such a sequestration order could zero out federal subsidies for Build America Bonds and other direct-pay bonds.

The issue has created a stir in the municipal market, with issuers and underwriters trying to figure out the impact on outstanding and new direct-pay bonds.

According to the Internal Revenue Service, there are seven types of direct-pay bonds containing subsidies ranging from 35% to 100%. These are taxable bonds in which the Treasury Department makes subsidy payments to issuers in amounts equal to a percentage of the bonds’ interest cost.

The IRS said four types of direct-pay bonds are still being issued, to the extent that allocations for them have not been used up. These are clean renewable energy bonds, new clean renewable energy bonds and qualified energy conservation bonds, all of which have subsidies of 70% of interest costs. Qualified school construction bonds, with subsidies of 100% of interest cost, can also be issued.

Market sources said some of these bonds are being priced and issued before the end of the year because of fear by issuers and underwriters that the tax bill pending in the House, which would terminate these and other tax credit bonds after 2017, would be enacted.

Issuances of these direct-pay bonds raise disclosure questions, some lawyers said. Issuers and their counsel must decide whether bond documents should disclose the potential problem of a complete loss of subsidies, particularly in cases where the subsidies are being used for debt service or would impair issuers’ financial conditions.

According to the IRS, three of the seven types of direct-pay bonds are outstanding but can no longer be issued. These include Build America Bonds, with subsidies of 35% of interest costs, recovery zone economic development bonds, with 45% subsidies, and qualified zone academy bonds, with 100% subsidies.

About $182 billion of BABs were issued in 2009 and 2010 and most of them remain outstanding.

Market sources said concerns about the potential for sequestration under the PAYGO Act -- which would be separate from the sequestration that annually occurs under the Budget Control Act of 2011 – could lead issuers to current refund their outstanding direct-pay bonds with tax-exempt bonds.

The documents for some direct-pay bond transactions contain extraordinary redemption provisions that state that if the subsidy payments are eliminated or cut by a certain amount the bonds can be called at par, in which case they would likely be current refunded by tax-exempt bonds.

The CBO letter sent to Hoyer responded to his question about whether any bill which would add $1.5 trillion to the deficit in the 2018-2027 period would be subject to the PAYGO Act. The act was written into law to generally ensure that most new spending by Congress during any session is offset by either spending cuts or added revenue elsewhere so that it does not increase estimated deficits.

The PAYGO Act requires the Office of Management and Budget to keep scorecards to report the cumulative revenues and outlays over five and ten year periods from new legislation passed during each session and to then determine if sequestration of mandatory federal programs is required to offset them.

If Congress passed a tax bill by year-end, for example, OMB would have to record average annual deficit increases of $150 billion per year for 10 years, CBO said.

Without any legislation to offset the estimated deficits or to wave or otherwise mitigate the PAYGO Act, OMB would be required, by Jan. 15, to reduce spending via sequestration in fiscal 2018, CBO said.

Legislation enacted during the current congressional session already shows a $14 billion credit. The annual deficit amount of $150 billion, reduced by the $14 billion credit during the session, would result in $136 billion.

Further, the PAYGO Act limits reductions to Medicare to four percentage points, which would be roughly $25 billion for fiscal 2018, CBO said, leaving $111 billion.

In addition, the law exempts some large accounts from any cuts, such as social security and low-income programs, leaving only $85 billion to $90 billion from which OMB could draw for cuts.

CBO said this amount would be “significantly less than the amount that would be required to be sequestered.”

“Given that the required reduction in spending exceeds the estimated amount of available resources in each year over the next 10 years, in the absence of further legislation, OMB would be unable to implement the full extent of outlay reductions required by the PAYGO law,” CBO’s Hall said.