Build America Bonds (BABs)

Exploring Build America Bonds (BABs): A Comprehensive Guide

In the wake of the 2008 financial crisis, the introduction of Build America Bonds (BABs) marked a significant initiative aimed at bolstering local economies and stimulating investment. This article delves into the intricacies of BABs, their types, restrictions, and the key distinctions from traditional municipal bonds.

Understanding Build America Bonds (BABs)

Build America Bonds emerged as taxable municipal bonds embedded with federal tax credits or subsidies, offering an innovative mechanism to finance capital expenditures for state and local governments. Introduced under President Obama's American Recovery and Reinvestment Act (ARRA) in 2009, BABs played a crucial role in addressing the economic challenges posed by the recession.

Types and Mechanisms of BABs

BABs were characterized by two primary variants: tax credit BABs and direct payment BABs. Tax credit BABs provided bondholders with a 35% federal subsidy on interest payments through refundable tax credits, while direct payment BABs involved the U.S. Treasury making direct payments to bond issuers equivalent to 35% of the interest owed to investors. These mechanisms aimed to lower borrowing costs for issuers and attract investors by offering competitive rates.

Restrictions and Legacy of BABs

Despite their efficacy in mobilizing capital, BABs were subject to certain restrictions. Notably, only new issue capital expenditure bonds issued before Jan. 1, 2011, were eligible under the program, with refinancing of old debts excluded. Furthermore, some traditionally tax-exempt issuers were ineligible for BABs.

Build America Bonds vs. Traditional Muni Bonds

A critical distinction between BABs and traditional municipal bonds lies in their tax treatment. While income from regular muni bonds is exempt from federal and some state taxes, BABs' interest income is subject to federal taxation, offering a nuanced investment landscape for discerning investors.