Build America Bonds (BABs)
Build America Bonds (BABs) were taxable municipal bonds created under the American Recovery and Reinvestment Act of 2009 to help state and local governments raise capital for capital expenditures during the recession. The program provided federal subsidies that lowered the effective borrowing cost for issuers and made municipals more attractive to investors. The BABs program expired for new issues on Jan. 1, 2011.
Purpose and context
- Introduced in response to the 2008 financial crisis to stimulate the economy and support infrastructure spending.
- Aimed to restore investor confidence in government-backed debt and ensure municipalities could access financing for projects when private credit markets were constrained.
How BABs worked
- BABs were taxable to investors (unlike most traditional municipal bonds, which are generally federally tax-exempt).
- To compensate for taxation, the federal government provided a 35% subsidy tied to interest payments. That subsidy either reduced investors’ after-tax cost (via tax credits) or lowered issuers’ net interest expense (via direct payments).
Types of BABs
- Tax-credit BABs
- Offered bondholders a federal tax credit equal to 35% of the interest paid.
- Credits were refundable and could be carried forward if the bondholder’s tax liability was insufficient to use the full credit.
- Direct-payment BABs
- The U.S. Treasury paid issuers 35% of the interest owed to investors.
- Issuers therefore faced a lower net interest cost and could offer competitive coupon rates to investors.
Example: A state could issue bonds paying 7.4% interest while effectively paying only 4.8% after the federal 35% subsidy.
Restrictions and eligibility
- The program was limited to new-issue capital expenditure bonds issued before Jan. 1, 2011; BABs could not be used to refinance existing debt.
- Certain traditionally tax-exempt issuers (for example, some private-party issuers and certain 501(c)(3) organizations) were not eligible to participate.
BABs vs. traditional municipal bonds
- Traditional muni bonds: interest is typically exempt from federal (and sometimes state) income tax for investors.
- BABs: interest was taxable at the federal level, but the 35% federal subsidy (via tax credit or direct payment) offset the tax burden and reduced issuers’ borrowing costs.
Key takeaways
- BABs were a temporary program (2009–2010) that combined taxable municipal bonds with a federal subsidy to lower borrowing costs for public capital projects.
- Two formats existed: tax-credit BABs (subsidy to investors) and direct-payment BABs (subsidy to issuers).
- The program was restricted to new capital expenditure issues and excluded certain issuers and refinancing.