Of the various funding and financing options available to state and local governments to support infrastructure projects, tax-preferred bonds are the most commonly used, and tax-exempt municipal bonds (“munis”) top the list. In fact, nearly 75 percent of outstanding debt issued by state and city governments is owned by U.S. households — most often through municipal bond funds. The tax- exempt status of munis makes them highly attractive investments for individual and institutional investors, and there is no cap on the amount of debt that state and local governments can issue.
However, munis have two important drawbacks: They cannot be used to finance projects with significant private-sector investment or ownership, which limits their ability to be used in the context of P3s, and they are not attractive to private investors with a low or zero marginal tax rate (e.g., public-sector pension funds, international investors). As an alternative to muni bonds, PABs can be used to facilitate private- sector investment in P3 infrastructure projects.
Unfortunately, PABs are constrained in the amount of private investment they can stimulate due to caps on each state’s annual issuance — qualified highway and surface freight transfer projects are subject to a nationwide $15 billion cap — and the fact that they are subject to the alternative minimum tax. Notably, during the financial crisis, Build America Bonds (BABs) provided a more flexible version of munis by giving state and local governments the option to receive transferable tax credits or a direct federal subsidy on the bond’s interest.
In addition to preserving its support for tax-exempt municipal bonds, the government should expand other tax-exempt bond options as a way of more efficiently leveraging federal funds and widening the pool of private investors engaged in financing, building, operating and maintaining America’s infrastructure.
- Maintain tax-exempt status for municipal bonds. Maintaining the tax-exempt status of municipal bonds is critical to guaranteeing that state and local governments will continue to be able to fund the expansion and upkeep of airports, roads, bridges and other public infrastructure through competitive, low-interest bonds.
- Expand PAB capacity for all infrastructure categories. The federal government should lift state- level volume caps for PABs, and states should provide exemptions from the PAB volume caps for additional infrastructure categories. For example, removing public drinking water and wastewater projects from the PAB volume cap is projected to produce up to $50 billion in additional private investment over a 10-year period, at a cost of just $201 million in forgone federal tax receipts.
- Offer alternative bond structures to appeal to a wider range of private investors. The more flexible structure of BABs was successful and efficient in attracting a much wider range of private capital into infrastructure projects. Congress should restore the BAB program, which was gutted by sequester budget cuts instituted by the 2011 Budget Control Act,
or create a similar bond program that would allow for one or both of the following:
- Flexible tax credits. Congress should offer transferable tax credits for bond-eligible projects. States could either transfer the tax credits to private-sector project sponsors or sell them to raise capital. In turn, private-sector sponsors could either claim the credits for themselves or sell them to raise capital.
- Direct payments. Congress should provide a direct-payment bond option, in which state and local governments receive direct federal payments to subsidize a portion of the taxable interest paid to private bond holders. In cases where private investors are subject to low or no federal income tax, state and local governments could then pass this subsidy on in the form of higher interest payments.