Sequestration rate for direct-pay bonds is 6.2% starting Oct. 1

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WASHINGTON — Federal subsidy payments made to issuers of Build America Bonds and other direct-pay bonds will be cut by 6. 2% in fiscal 2019 under sequestration, the Internal Revenue Service has announced.

The reduction will shave 2.17 percentage points off the 35% federal subsidy, reducing it to 32.83% for the fiscal year that begins Oct. 1.

The sequestration rate cuts are not cumulative and reset at a new percentage annually.

The new reduction has fallen from cuts of 6.6% fiscal 2018 and 6.9% in fiscal 2017, continuing a generally downward trend. The initial sequestration cut in fiscal 2013 was 8.7%.

Sequestration was enacted as part of the Budget Control Act of 2011 for spending beginning in March 2013. The cuts are automatic, annual, across-the-board reductions to defense and non-defense discretionary and mandatory spending programs which stem from Congress's failure to reach an agreement over how to significantly cut the deficit.

In addition to cutting federal subsidy payments for BABs, the sequestration cut also applies to qualified school construction bonds, qualified zone academy bonds, new clean renewable energy bonds, and qualified energy conservation bonds.

The Bipartisan Budget Act of 2018 enacted in February of this year suspended sequestration for discretionary spending in fiscal 2018 and 2019, which has cleared the way for increased federal aid to state and local governments.

The cuts still apply to mandatory spending such as subsidies to direct pay bonds. The Bipartisan Budget Act also extended the sunset date for sequestration by another two years to Sept. 30, 2027, from the previous end date in 2025. The initial end date in 2021 has been extended several times.

“Sequestration levels are once again heading in the right direction, though, the only practical solution for issuers of Build America Bonds would be that the sequestration levels were restored to the original 35% subsidy payment,” said Emily Brock, director of the federal liaison center for the Government Finance Officers Association.

“Of those issuers whose BABs are callable, the time frame to do so is near. Many are weighing options in the new environment post-2017 Tax Cuts and Jobs Act,” Brock said.

The Securities Industry and Financial Markets Association has been a continuing critic of the use of sequestration cuts on subsidies for Build America Bonds.

“Issuers entered into BAB transactions in good faith on the promise that subsidy payments would continue in full as long as bonds are outstanding,” said Michael Decker, managing director and co-head of SIFMA’s Municipal Securities Division. “With the sequestration, that promise has been broken.”

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