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Treasury Notes

 The Case for Bringing Back BABs

By: John Bellows
5/18/2011

At a time of mounting deficits and a need to cut costs from the state to the federal level, there’s a strong case to be made for bringing back the Build America Bonds (BABs) program. Created as part of the Recovery Act, BABs are taxable bonds for which the U.S. Treasury Department paid a 35 percent direct subsidy to the issuer to offset borrowing costs.

According to a new Treasury analysis, state and local governments that issued BABs realized considerable savings compared to what they would have paid to issue tax-exempt bonds. The report estimates that BABs issuers saved, on average, 84 basis points – or .84 percent – on interest costs for 30-year bonds and also received significant savings on shorter maturities, as compared to traditional tax-exempt bonds.

Due to the large savings in interest costs, state and local governments that issued BABs saved an estimated $20 billion in borrowing costs, on a present value basis, as compared to tax exempt bonds. In other words, had the state and local government that issued BABs issued comparable tax-exempt bonds instead at the same time, their borrowing costs would be around $20 billion higher in present value. This is considerably greater than the net cost to the federal government of the BABs program.

In its less than two years of existence, the program was decidedly a success – in addition to lowering borrowing costs, it helped to restore a badly damaged municipal finance market and supported job creation through thousands of much-needed infrastructure projects. From its inception in April 2009 until it expired on December 31, 2010, state and local governments made 2,275 separate BABs issues, which supported more than $181 billion of financing for new public capital infrastructure projects such as schools, bridges and hospitals.

A new paper released last month by the Center for American Progress concurs. “All in all, the Build America Bonds experiment was successful: It strengthened the municipal market, reduced inefficient returns to high income bond buyers, and brought about long-overdue investment in infrastructure at the state and local level. It did so at a time when broader financial markets were fragile and the economy was struggling out of the deepest recession in two generations,” wrote the paper’s authors Jordan Eizenga and Seth Hanlon.

In light of the program’s accomplishments, the President proposed in his FY 2012 Budget to extend and expand the Build America Bonds program. The President’s Budget proposes to make the BABs program permanent at a 28 percent subsidy rate, making the program revenue-neutral compared to tax-exempt bonds, meaning it will not have any effect on the Federal Budget deficit. The Budget proposal also expands the program to cover a broader set of investment such as capital infrastructure projects and financing for nonprofit colleges and hospitals.

A permanent BABs program offers a more efficient direct municipal borrowing subsidy, a broader market, and a more sustainable long-term financing option for state and local governments. President Obama’s proposal to extend and expand the BABs program would help municipalities continue to finance much-needed building projects at a lower cost. As we’re all looking for ways to save money and be more efficient with taxpayer dollars, the case for bringing back BABs couldn’t be stronger.

John Bellows is the Acting Assistant Secretary for Economic Policy

Posted in:  Build America Bonds
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