Are Build America Bonds Bad for Taxpayers? Only Ones Like Warren Buffett!
The National Bureau of Economic Research says Build America Bonds disadvantage taxpayers. They do -- but only very wealthy ones.
Build America Bonds -- a variation on the traditional tax-free municipal bond -- are the current sensation of the bond market, although they have given some people some serious willies. (Warren Buffett thinks cities and towns are in too deep.) They came out of the stimulus package, passed in early 2009 when financial markets had largely seized up. BABs aren't tax-free, but the federal government pays 35 percent of the interest costs incurred by municipalities who issue them.
BABs were a raging success, and in 2009 issuance surpassed $60 billion, or about one-fifth of the muni market. Most importantly, they reliquified the market, relieving city halls like the one in Albany (pictured above). The NBER researchers point out that they lowered borrowing costs for issuers (state and local entities). Because many investors, such as pension funds or foreigners, worry less about optimizing their U.S. tax bills (indeed, foreigners have none), BABs also increased the size of the market for municipal securities. Great stuff.
The NBER paper is narrowly written for specialists, so there's no point in criticizing what the authors do not write. But Andrew Ang, Yuhang Xing (both of Columbia University) and Vineer Bhansali (from PIMCO, the bond giant) do include this somewhat inflammatory sentence about where that federal subsidy goes, one that demands some context:
In this light, the BAB program can be interpreted as a wealth transfer from the natural holders of municipal bonds, who are individual U.S. taxpayers, to corporations, pension funds, and foreign investors not subject to individual U.S. income taxes.Corporations. Foreigners who don't pay income taxes. They get the benefits, instead of the taxpayers who also buy the bonds. Ugh. Sounds like bad stuff, right?
But unless the feds are going to swear off supporting this market at all -- a dicey proposition, given parlous state and local finances -- then the question is not whether there is a wealth transfer, but from where and to where. Traditional municipal bonds cost the Treasury more than the actual interest costs and mainly benefit very wealthy individuals (John Mitchell, the Watergate-famous attorney general for Richard Nixon and former muni lawyer, nixed changes to the regime in the 1970s.) Build America Bonds cost the Treasury less money, and spread the risks of default (something the NBER authors assume away) across a broader base.
So taxpayers that have more average incomes than the very wealthy should ask themselves: if we have to subsidize state and local borrowing, do we do it with a transfer to mainly wealthy Americans, or a larger pool of individuals and institutions beyond U.S. borders? As long as it lowers borrowing costs for strapped states and localities, I vote the latter. I'm guessing Warren Buffett, with his focus on wealth inequality in America, would agree.
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