Build America Bonds

Abstract

Build America Bonds (BABs) are a new form of municipal financing introduced in 2009. Investors in BAB municipal bonds receive interest payments that are taxable, but issuers receive a subsidy from the U.S. Treasury. The BAB program has succeeded in lowering the cost of funding for state and local governments with BAB issuers obtaining finance 54 basis points lower, on average, compared to issuing regular municipal bonds. For institutional investors, BAB issue yields are 116 basis points higher than comparable Treasuries and 88 basis points higher than comparable highly rated corporate bonds. For individual investors, BABs represent poor deals compared to regular municipal bonds. Thus, on average the Federal government subsidy disadvantages individual U.S. taxpayers, who are the main holders of municipal bonds, and benefits new entrants in the municipal bond market.

Keywords: Municipal debt, tax-exempt bonds, public finance, tax subsidy

JEL Classification: G12, G28, H20, H24