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A Defense Of The Build America Bonds Program

Our guester bloggers are Jordan Eizenga, Economic Policy Analyst at the Center for American Progress, and Seth Hanlon, Director of Fiscal Policy for the Doing What Works Project.

In their zeal to slash spending and tear down government programs, many conservatives seem unfazed by the fact that some of the programs they’re targeting actually make government leaner and more efficient. Case in point: The Build America Bonds program, which enjoyed a short, successful life from its creation in early 2009 until its untimely death at the end of 2010. The Build America Bonds (BABs) program was an innovative finance tool that saved state and local governments $12 billion in financing costs.

In his budget released this week, President Obama proposes to bring the program back. But Sen. Orrin Hatch (R-UT), the ranking member on the Senate Finance Committee, dismissed the proposal, claiming that BABs are “simply a disguised state bailout.” They are nothing of the sort.

For nearly a hundred years, the federal government has promoted investments by state and local governments through the tax exemption for municipal bonds. By carving out a special, permanent tax break for municipal bond buyers, the federal government allows states and localities to issue bonds that pay lower rates. Tax-exempt bonds are therefore a $31 billion subsidy program for state governments.

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This is a clumsy and highly inefficient way of providing a federal subsidy. Of that $31 billion in lost revenue, 20 percent is siphoned off as a windfall to high-income bond buyers. Only 80 percent of it actually helps lower municipal borrowing costs.

For decades, people have asked: Why not cut out the middle-man and provide the subsidy directly to states? In 2009, BABs were created to do just that. BABs are bonds issued by states that pay taxable interest. But that interest is directly subsidized by the federal government. That makes Build America Bonds a more efficient subsidy.

Before the BABs program expired, states and localities had the option of issuing Build America Bonds or regular tax-exempt bonds. Over the program’s two-year lifespan, BABs grew increasingly popular.

Build America Bonds were “the biggest thing to hit the municipal bond market in a generation. It’s clearly been a success as a means of stimulating the economy,” said Amy Resnick, the editor in chief of Bond Buyer newspaper.

Perhaps most importantly, BABs expanded and stabilized the market in the months following the 2008 financial crisis, when demand for traditional tax-exempt bonds was dangerously weak.

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Today, the market is distressed again, partially attributable to Congress’s failure to extend BABs at the end of 2010. President Obama proposes to bring back BABs at a revenue neutral subsidy rate that results in zero net cost to the federal government while saving taxpayers at the state and local level.Doing so, will provide crucial support for job-creating infrastructure investment at a time when state and local governments face unprecedented difficulty in raising funds.

Yet critics like Senator Hatch perpetuate the myth that the program bails out irresponsible states. It’s a misleading smokescreen. BABs subsidize the interest on state and local government debt in the same manner as tax-exempt bonds — a permanent federal government program whose inefficiencies conservatives show no interest in addressing. The only meaningful difference between tax-exempt bonds and BABs is that BABs are 20 percent more efficient.

What explains the knee-jerk opposition to such a successful program? It seems in part based on the fact that BABs entail direct government spending, while tax-exempt bonds spend money covertly through the tax code.

This is a meaningless distinction. A $31 billion program is a $31 billion program. Conservatives who think they are making government smaller by eliminating successful alternatives like BABs are really only making government worse.