Build America Bonds-the Key to Rebuilding our Crumbling Infrastructure?

Build America Bonds (BABs) may return after a 10-year absence as part of U.S. President Joe Biden’s $2.25 trillion plan to finance the country’s infrastructure needs and to create new jobs. Among the many “traditional” transportation, energy, and communications infrastructure provisions, the plan proposes major investment in housing, community development, and climate change/green energy.

One of the few areas that Republicans and Democrats can agree on is that the U.S. needs a major infrastructure overhaul. The disagreements between them are which provisions are worth running the federal deficit higher, as well as how to finance such a large effort.

Even by the most modest estimates, the cost to repair our nation’s infrastructure is trillions of dollars. The country’s overall infrastructure needs over the next 10 years total nearly $6 trillion, according to a report published earlier in March by the American Society of Civil Engineers. It says there’s a $125 billion backlog on bridge repairs, a $435 billion backlog for roads, and a $176 billion backlog for transit systems.

One vehicle by which to finance infrastructure plans: Build America Bonds (BABs). BABs are special municipal bonds that allow states and counties to float debt with interest costs subsidized by the federal government.

BABs were utilized by the Obama administration during the aftermath of the financial crisis to help jumpstart the economy. They allowed states, cities, schools, airports, mass transit agencies, and others to sell for a limited time taxable debt with the federal government contributing 35% of interest costs. Between April 2009 and when the authorization expired at the end of 2010, $181.5 billion of BABs were issued to fund construction projects aimed at helping the nation recover from the financial crisis.

According to Citigroup’s Head of Municipal Bonds Strategy Vikram Rai, the beauty of subsidizing the interest associated with muni bonds is that every dollar spent by the federal government works to reinforce the integrity of larger spending projects that, legally, only states and localities have the power to pursue. The federal government owns less than 10% of the nation’s infrastructure, while the rest is operated by states, cities and the private sector.

When the federal government underwrites BABs, it allows states and cities to issue far more debt than investors would otherwise accept without high interest costs and doubt over whether or not they would be able to repay.

Most bonds issued by state and local governments under “normal” conditions are attractive to investors because the interest is generally exempt from federal income taxes. As a result, U.S. investors are willing to accept a lower interest rate than they would otherwise demand. But BABs are taxed by the federal government. By making them subject to federal taxes, state and local governments are forced to offer higher interest rates on their bonds to guarantee investors the same effective rate of return.

The drawback of BABs is that the federal government is still on the hook for billions of dollars’ worth in interest costs until the BABs mature.

The price tag and some Republicans who were not fans of BABs 10 years ago, may slow approvals down.

But with the nation’s infrastructure in dire straits and our history of public projects effectively helping our communities emerge from severe financial hardship, perhaps BABs will be viewed as a compelling option to fund infrastructure projects that, in time, eventually pay for themselves through job creation and tax revenues.

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