Build America Bonds (BABs) were a type of taxable municipal bond introduced as part of the American Recovery and Reinvestment Act of 2009. BABs provided state and local governments with additional financing options through federal subsidies and tax credits. This initiative aimed to stimulate the economy during the Great Recession by reducing borrowing costs for municipal issuers.
Types of Build America Bonds
Direct Payment BABs
Direct Payment BABs allowed issuers to receive a subsidy from the federal government equal to 35% of the interest paid to investors. This direct subsidy helped issuers lower their net borrowing costs and made these bonds an attractive option for large public projects.
Tax Credit BABs
Tax Credit BABs provided bondholders with a tax credit equivalent to 35% of the interest on the bonds. Instead of receiving direct payments, investors benefitted from reduced federal income tax liabilities, incentivizing higher participation in the bond market.
Restrictions and Requirements
BABs came with specific restrictions and requirements designed to align the bond’s use with public interest:
- Eligible Projects: The proceeds had to be used for capital expenditures, with limited exceptions for refinancing existing debt.
- Compliance: Issuers were required to ensure compliance with federal regulations, maintaining detailed records and reporting to the Internal Revenue Service (IRS).
- Expiration: BABs had a sunset provision, which meant the issuance authority expired after December 31, 2010.
Comparison with Other Bonds
BABs vs. Traditional Municipal Bonds
Traditional municipal bonds are typically tax-exempt, meaning that interest income is not subject to federal income tax. In contrast, BABs were taxable, with the advantage of federal subsidies and tax credits compensating for the taxability.
BABs vs. Treasury Bonds
Treasury bonds are issued by the federal government and have different risk and return profiles compared to municipal bonds. BABs, backed by local governments but with federal support, often offered higher yields to compensate for the taxable nature and varying credit risks associated with municipal entities.
Historical Context and Impact
The introduction of BABs was a significant move during the economic downturn, providing approximately $181 billion in financing for infrastructure and other public projects. The program’s success garnered attention, although it was not renewed post-2010, leading to discussions about potential revivals in future economic strategies.
Applicability and Use Cases
BABs were instrumental in funding various infrastructure projects, including transportation, education, and public utilities. The direct payment option made them particularly useful for large-scale capital projects, while tax credit bonds appealed to investors seeking tax benefits.
Frequently Asked Questions
What happened to Build America Bonds after 2010?
The authority to issue new BABs expired at the end of 2010. Existing BABs continue to trade in the market, and their mechanisms of federal subsidy or tax credit remain intact for their holders.
Are Build America Bonds still a viable investment?
Existing BABs can still be a viable investment, particularly for those looking for income streams with federal support factors. However, their rarity in new issues limits availability.
How do BABs affect municipal bond portfolios?
BABs add a taxable dimension to municipal bond portfolios, often resulting in higher yields. Investors must weigh the benefits of federal subsidies or tax credits against the tax implications.
Related Terms
- Municipal Bonds: Bonds issued by state or local governments, often tax-exempt for federal tax purposes.
- Taxable Bonds: Bonds subject to federal income tax on interest.
- Federal Subsidy: A financial aid provided by the federal government to lower the net cost of borrowing.
- Tax Credit: A direct reduction in tax liability, different from deductions.
Summary
Build America Bonds revolutionized municipal financing during a critical economic period by introducing taxable bonds with federal support. Understanding the types, restrictions, and comparison with other bonds helps investors and issuers navigate and capitalize on similar opportunities in evolving economic landscapes.
References
- IRS. “Build America Bonds”. [Link to official IRS page on BABs]
- U.S. Department of the Treasury. “Frequently Asked Questions on Build America Bonds”. [Link to Treasury FAQ page]
- American Recovery and Reinvestment Act of 2009. [Link to official legislation]
By exploring the intricacies of Build America Bonds, this guide serves as a resource for financial professionals, investors, and policy-makers seeking detailed knowledge on this innovative bond mechanism.
