Build America Bonds are tax credit bonds introduced as part of the February 2009 American Recovery and Reinvestment Act (ARRA) and are administered by the Treasury Department. A Build America Bond (BAB) is a bond issued prior to January 1, 2011 by a state or local entity for governmental purposes (non-private activity purposes) and for which the issuer elects to have the interest on the bond be taxable in return for a federal interest subsidy. Governmental purposes include financing surface transportation projects. There is no volume cap on the amount of BABs that may be issued in 2009 and 2010.
Tax Credit BABs are bonds for which the investor (bondholder) receives a tax credit equal to 35 percent of the amount of interest paid by the state or local government issuer, net of the tax credit. Tax Credit BABs can be used for the same purposes as tax-exempt borrowing (i.e., new construction, current refundings or one advance refunding, and working capital.) The federal interest subsidy on a Tax Credit BAB represents about 26 percent of total interest expense.
For example, if an investor required a ten percent return ($100) on a $1,000 bond, the issuer would pay $74.07 in interest and the investor would receive a supplemental credit equal to 35 percent of the interest the issuer paid, or $25.93, to provide the total desired annual return of $100. In this manner, the effective interest rate for the issuer is reduced by 26 percent. The investor can apply the tax credits against regular income tax liability and alternative minimum tax, and unused tax credits may be carried forward to the next year.
Direct Payment (or qualified) BABs provide a Federal subsidy through a refundable tax credit paid directly to state or local government issuers in an amount equal to 35 percent of the gross interest payable to investors, making the subsidy itself 35 percent. The credit is "refundable" in the sense that the issuer can present it directly to the Treasury for cash, and the Treasury has permanent indefinite budget authority to make the cash payment (i.e. there is no annual appropriation risk).
For example, under this approach on a $1,000 bond, the issuer would pay 100 percent of the taxable rate interest cost to the investor ($100) and apply for a refundable tax credit itself from the U.S. Treasury in an amount equal to 35 percent of the gross interest paid by the issuer ($35).
Direct Payment BABs provide a higher subsidy than the Tax Credit BABs (35 percent vs. 26 percent), and are much more readily marketable, as there is no need for investors to ensure they have sufficient tax liability to make the tax credit worthwhile. However, Direct Payment BABs are more limited in purpose because the proceeds are effectively restricted to new construction projects (i.e., no refinancing or working capital). From an investor's perspective, the Direct Payment BAB is indistinguishable from a conventional taxable bond, as the annual return is paid entirely in cash. The diagram below illustrates the two variants of BABs.
Illustration of Build America Bonds: Direct Payment vs. Tax Credit Structure with 10% Return
The Department of the Treasury has been compiling monthly statistics on BAB issuances and volumes since the program's inception. Detailed state-by-state data on issuance dates, purposes, and amounts are provided at the end of this June 2010 Press Release. Note that this information is inclusive of all BAB issuance purposes, which include a variety of infrastructure improvements, not just surface transportation.