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Transportation Funding & Financing

Tax Credit Bonds

Overview

Tax credit bonds are a debt instrument where, rather than investors/bondholders receiving periodic interest and principal payments, they receive federal tax credits of up to 100 percent of the interest amount in lieu of or in addition to partial interest payment over the life of the bond and full repayment of principal upon its maturity. Investors apply the tax credits to their federal tax liability. In turn, the borrower is responsible for paying off the principal at maturity (in a balloon payment), which it can do by different means, such as investing a portion of the bond proceeds in Treasury securities sufficient to pay off the principal or otherwise setting aside local revenues over the life of the bond. A technical paper prepared for the National Surface Transportation Policy and Revenue Study Commission estimates the federal subsidy in present value terms for financing of this nature to be 75 percent over a 25-year bond in the case of a 100 percent subsidy. As such, tax credit bonds afford borrowers significant project savings, as their responsibility would only be 25 percent in present value terms. The paper also identifies several other benefits associated with tax credit bonds including:

  • Subsidy Efficiency - because borrowers can receive 100 percent of the financial subsidy, taxable tax credits are more economically efficient than other types of tax incentives
  • Market Discipline - the government does not assume any credit risk and tax credit bonds are only issued when a project is backed by a reliable repayment stream
  • Reduced Administration - the federal government does not manage or oversee the program, as it would with a direct grant or federal loan program
  • Budget Leveraging - tax credits do not require discretionary budget resources; their budgetary cost is amortized over the bond's term, rather than scored upfront or during a project's construction period, as is the case for grants

Tax credit bonds are a relatively new concept to transportation. They were first authorized by Congress in 1997 to subsidize a school modernization program and have since been expanded to programs that support renewable energy projects and that form part of the Hurricane Katrina recovery program. Tax credit bonds called Build American Bonds are now available to surface transportation projects through 2010 as part of the American Recovery and Reinvestment Act passed in February 2009.

Build America Bonds

Resources

National Surface Transportation Policy and Revenue Study Commission Briefing Paper 5A-14 discusses tax-preferred investment products to stimulate investment in surface transportation including tax credit bonds.