Rays of Hope for Highway, Water Programs - Washington Insider
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Rays of Hope for Highway, Water Programs

By Christian Klein

Article Date: 07-01-2010
Copyright(C) 2010 Associated Equipment Distributors. All Rights Reserved.

BABs and PABs give states some lower-cost alternatives, but in the end, they still amount to more public debt.

The current highway reauthorization has been a train wreck.
Needs are overwhelming, but a lack of cash has brought the process to a grinding halt. There’s simply not enough money to pay for the current level of highway investment, let alone grow the road program. Congress can’t raise the gas tax because voters don’t trust that the money will be spent wisely. And our national debt is so big that lawmakers are reluctant to institutionalize more deficit spending for fear of incurring voters’ wrath.
As the clock winds down to the November elections and the atmosphere on Capitol Hill becomes ever more partisan, the chances of finishing the highway reauthorization diminish. But while the outlook for a multiyear surface transportation bill is bleak, new mechanisms to help states access money for infrastructure investment have gained traction and may be the lifeline the construction industry needs in the interim.
First, there’s the Build America Bond (BAB) program. Created by the 2009 stimulus bill, BABs are designed to encourage infrastructure investment by reducing state and local government borrowing costs for capital projects (including roads, bridges, sewers, drinking water systems, schools, energy projects, etc.)
Under the BAB program, the federal government makes direct payments to municipal bond issuers equal to 35 percent of the interest payment on the BAB. For example, if a state issues a BAB at a 10 percent taxable interest rate, the Treasury would pay the state 3.5 percent of the interest, so the state’s net borrowing cost would be only 6.5 percent. Those higher returns make BABs attractive to investors that have traditionally steered clear of municipal bonds, including pension funds, those in lower tax brackets, and foreign investors.
The BAB program has apparently been a big success. The Treasury estimates 1,306 separate issuances worth $106 billion as of the end of May, and suggests that BABs now constitute more than 20 percent of the municipal bond market.
On the heels of the BAB program, state and local governments may soon have another way to attract even more private investment for infrastructure as Congress is considering lifting the cap on Private Activity Bonds (PABs) for water projects.
Interest on municipal bonds is generally excluded from gross income for federal income tax purposes if the bonds are used to finance direct activities of governmental units or are repaid using government revenues. However, interest on municipal bonds issued to finance activities of private persons is taxable unless the bonds have been issued for certain limited purposes (“qualified private activity bonds”).
PABs can be used for sewer projects and for drinking water infrastructure if the water will be made available to members of the general public (including electric, industrial, agricultural, or commercial users), and the facilities are operated by a governmental unit or a governmental entity sets the rates. However, to limit the losses to the Treasury from the tax benefit, PABs are subject to state volume caps. In other words, there’s a maximum aggregate limit on PAB issuances in each state. That limits both the size and number of PAB projects. The Environmental Protection Agency has suggested that eliminating the cap could attract as much as $6 billion per year in new private capital for drinking water and sewer investment. AED estimates that would add $720 million per year to equipment markets.
As this issue of CEDwent to press, the House had just passed a tax extenders bill that included language lifting the state volume cap on PABs for drinking water and sewer projects. The same tax bill would extend the BAB program through 2012, albeit with a reduced 32 percent reimbursement rate next year and 30 percent reimbursement in 2012.
Extending the BAB program and lifting the PAB cap are both good ways to help state and local governments borrow money for infrastructure. That additional investment is desperately needed, and the construction work will help ailing equipment distributors recover from the recession. But, in the final analysis, BAB and PAB money ultimately has to be paid back and only adds to public debt. Neither program is a real alternative to new user fees that create sustainable revenue streams for greatly expanded infrastructure investment.

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