CHICAGO — Michigan would issue nearly $4 billion of tax-exempt bonds to pay off a $3.7 billion obligation to the federal government for unemployment insurance under a proposal being considered by state Treasurer Andy Dillon.

Dillon, the former Democratic House speaker, was tapped by Republican Gov. Rick Snyder for the treasurer position in December. He said last week that the borrowing is under consideration as one way to replenish the state’s federal unemployment trust fund and to avoid a looming $117 million interest payment and a federal tax on states with shortfalls.

Michigan is not alone in eyeing the tax-exempt market as a way to finance their federal obligations. Texas priced $1.2 billion of bonds last November to pay off its federal shortfall, and since then Idaho, Arkansas, and other states have publicly said they’re considering the option.

“There are a whole bunch of states that are soon to be in the same situation,” said Chris Dembowski, a principal with Lansing-based office of Miller, Canfield, Paddock and Stone PLC.

Many states have struggled to maintain their trust funds amid climbing jobless rates and turned to Washington for loans. Until Jan. 1, those loans were interest-free, thanks to a provision in the federal stimulus program. Now many states, like Michigan, are facing high interest payments later this year. Aggravating the problem is a federal tax that is imposed if a state, like Michigan, carries a deficit in the unemployment trust for more than two years.

“If you don’t want the federal tax to kick in, you need to pay off that obligation,” Dembowski said. “There are at least 20 states that by the end of this year are going to be in a situation like Michigan.”

Michigan will owe a $117 million interest payment in September if it doesn’t pay off its $3.7 billion obligation. The payment is based on a 4.1% federal interest rate, and many states believe they can achieve lower interest costs by tapping the tax-exempt market. Texas saw all-in borrowing costs around 3% on its $1.2 billion borrowing, according to Dembowski.

The Texas Public Finance Authority in November sold the unemployment compensation obligation-assessment revenue bonds that featured short maturities. The bonds have been trading around 2.7%.

In Michigan, lawmakers would need to craft and pass legislation that would allow the financing. There is no timeline for a decision, a treasury spokesman said.

The state has twice before considering borrowing to cover the debt, but each time opted to simply pay off the loan. This time could be different, Dembowski said.

“It’s a much bigger problem now than it was before,” he said. “The amount owed is substantial enough that the state might say if we don’t try to fix this thing, Michigan could be at a competitive disadvantage to other states, because our unemployment taxes will be higher and employers look at those things.”

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.