What are Build America Bonds?

One of the ways that states and local governments pay for capital projects like schools or roads is by selling bonds to investors. Like all bonds, "municipal bonds" pay interest to anyone who buys the bond until it matures.

Because of a special rule in the tax code, the buyers of municipal bonds don't have to pay income tax on these interest payments. And since the interest on municipal bonds is tax free, buyers are usually willing to buy them even if they get lower interest payments. And the lower interest rate also saves state and local governments money.

In the stimulus bill of 2009, Congress created Build America Bonds—a new way for state and local governments to finance infrastructure projects. Build America Bonds differ from traditional tax-exempt bonds in two primary ways: First, the interest on the bonds is taxable to buyers; and second, the federal government makes direct subsidy payments to state and local governments to cover a portion of their interest payments.

How did Build America Bonds improve the municipal bond market?

Because Build America Bonds were taxable, they attracted a broader array of investors than tax-exempt bonds, which only appeal to investors looking to reduce their U.S. taxes. As a result, state and local governments saved an estimated $12 billion by issuing Build America Bonds. Unfortunately, Build America Bonds were only authorized for two years, and Congress allowed the program to expire at the end of 2010.

Why is it important to revive the Build America Bonds program?

Without Build America Bonds, there are fewer potential buyers of municipal bonds. This has caused interest rates to significantly rise for state and local governments, pushing many governments to put off long overdue infrastructure projects. That's why Congress should renew Build America Bonds and make them permanent. They are a proven and cost-effective way to leverage investments in infrastructure at the state and local level.