Build America Bonds Cut Into Muni Bonds, Raise Debt Concerns

Published August 9, 2010

A new type of taxable bond is raising concerns the federal government is encouraging state and local governments to take on debt they could have trouble repaying.

Build America Bonds are intended to help stimulate the economy. Thirty-five percent of the interest costs are subsidized by the federal government, making it cheaper to issue long-term debt with Build America Bonds than with traditional tax-exempt municipal bonds.

Lori Johnson, director of strategic debt management at North Carolina State University, said N.C. State expects to save $350,000 a year, or $7 million overall, on the $59.6 million in Build America Bonds it issued in April for projects including athletic and dining facilities.

“They’ve been a very good program, and we’ve been able to take advantage of them at a good time to save money,” Johnson said. “I like to borrow money as cheaply as I can.”

Surge in State Debt
State tax-supported debt nationwide increased by 10.3 percent in 2009, to $460 billion, more than double the rate in 2008, according to Moody’s Investors Service. Moody’s attributed part of this increase to the Build America Bonds program.

Joe Coletti, director of health and fiscal policy studies at the John Locke Foundation in Raleigh, North Carolina, said Build America Bonds are another type of borrowing that doesn’t require voter approval, along with tax increment financing and certificates of participation.

“The federal government is encouraging local governments that don’t have money to go out and borrow more money, and they’re doing this without having to ask the taxpayers’ permission,” Coletti said.

The Internal Revenue Service, which has been looking into how some of the bonds were priced, would not answer questions about the amount of subsidies individual issuers were receiving, citing taxpayer privacy.

$125 Billion Since 2009
Municipal bonds traditionally have been tax-exempt; the federal government does not require investors to pay federal income tax on the interest paid. State and local governments sometimes don’t tax the interest. The market for municipal bonds suffered in 2008 because of the recession, and in early 2009 Congress created Build America Bonds.

About $125 billion in Build America Bonds have been issued so far, with California, New York, and Texas issuing the most. The bonds accounted for approximately 19 percent of the municipal bond market from April to December 2009.

The bond program is scheduled to expire at the end of this year, but Congress is considering whether to renew it with a lower interest subsidy.

Sarah Okeson ([email protected]) is a contributor to Carolina Journal, published by the John Locke Foundation in Raleigh, NC, where a version of this article first appeared. Used with permission.