WASHINGTON — Municipal market participants yesterday urged lawmakers to expand and extend or make permanent the two-year bond initiatives in the new stimulus law, but said that the tax-credit bond programs are not working and should instead be recast with direct-pay options, like the Built America Bond program.

Alan Krueger, the Treasury Department’s assistant secretary for economic policy and chief economist, who also testified before House Ways and Means select revenue measures subcommittee, was bullish on BABs but unwilling to commit to any expansions or extensions, saying revenue impacts must be considered.

Subcommittee chairman Richard Neal, D-Mass., had asked Krueger and a panel of market participants to testify about the effects on the muni market of the two-year bond initiatives in the recently enacted American Recovery and Reinvestment Act.

“Any or all of these programs warrant extension or expansion,” said James Esposito, a managing director at Goldman, Sachs & Co.

“I think it is necessary to extend many of these programs in order for Congress to get a sense of the benefits they can provide,” agreed Gary Bornholdt, a partner at Nixon Peabody LLP and former legislative counsel to the Joint Tax Committee.

Bornholdt said “there are sound policy reasons for making [some ARRA] provisions permanent,” such as one that exempts tax-exempt bonds from the individual and corporate alternative-minimum tax and another that eases limits on bank deductible bonds.

Michael Decker, co-chief executive officer of the Regional Bond Dealers Association, also called for permanently lifting the application of the AMT on tax-exempt bonds. He said the ARRA provision that attempted to give an AMT holiday to refunding bonds if the original bonds were sold after Dec. 31, 2003, effectively prohibits almost all refundings of outstanding AMT bonds because most of the bonds were sold with a 10-year call protection and private-activity bonds cannot be advance refunded.

Patrick McCoy, finance director for New York’s Metropolitan Transportation Authority, told the lawmakers, “I am hopeful that Congress will look at all of the bond provisions included in the ARRA and make them permanent so that state and local governments can continue to benefit from these after they are scheduled to expire next year.”

McCoy also urged the lawmakers to consider allowing governments to do an additional advance refunding of bonds, streamline complex arbitrage rebate rules, increase the allowable percentage of private use permitted in bond-financed public projects, and expand direct grant programs for infrastructure projects.

Robert Culver, president and CEO of MassDevelopment, called on the lawmakers to make permanent the ARRA provisions that ease limits on bank deductibility of certain bonds, allow Federal Home Loan Banks to issue letters of credit for all bonds, and expand the use of small issue industrial development bonds.

The small-issue IDB provisions temporarily expand the definition of qualified manufacturing bonds to include facilities that help produce intangible property such as software and also allow the bonds to be used for property that is functionally related and subordinate to manufacturing facilities.

“MassDevelopment strongly supports making these enhancements permanent to bring manufacturing bonds into the 21st century,” he said.

Culver also asked that states be given control over allocations of recovery zone bonds and choosing the projects to be financed with clean renewable energy bonds.

But Culver said that while the ARRA authorizes the issuance of more clean renewable energy bonds, qualified energy conservation bonds and other taxable, tax-credit bonds, “these bonds are dependent on a vibrant tax-credit market that does not exist at this time.”

He called for the BAB direct-pay option to be extended to CREBs and urged that Congress create a new category of private activity, tax-exempt facility bonds to finance renewable energy projects rather than authorize more qualified energy conservation bonds.

Bornholdt agreed that the market for tax-credit bonds “generally has been illiquid,” adding: “The initial success of the [BAB] direct payment program suggests that Congress should consider applying this direct payment approach to other types of tax-credit bond programs.”

But he urged that the BAB program be expanded so that these bonds can be issued for any tax-exempt governmental purpose, not just for capital expenditures. BABs are taxable bonds that allow the issuer to either receive a cash payment from the federal government or direct the federal government to provide investors a tax credit. The subsidy equals 35% of the interest paid to investors.

Krueger said that BABs provide the most efficient federal subsidy to state and local governments and that the early market reception “has been very positive.” State and local governments issued about 36 issues of BABs totaling about $9.5 billion between April 15 and May 20 — about 20% of the amount of tax-exempt bonds issued during the same period, Krueger said, citing reported data.

Krueger, Esposito and Decker each said BABs have lowered borrowing costs for muni issuers.

However, Krueger said the BAB program presents a “major administrative challenge” for the Treasury and the Internal Revenue Service because they basically wind up as paying agents for a significant portion of the state and local governmental bond market. Treasury and the IRS will have to develop an electronic payment system, tax compliance safeguards and tax compliance procedures, he said.

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