12/06/2010 05:28 pm ET Updated May 25, 2011

Extend Build America Bonds Too

As Congress and the administration work toward a compromise on extending the Bush tax cuts and emergency unemployment benefits, another tax cut should also be extended: the Build America Bonds (BABs) program. Build America Bonds have provided crucial support for state and local governments at a time when they faced unprecedented stress raising funds. And, that's right, BABs were structured as a tax program.

Build America Bonds are taxable municipal bonds, for which the federal government pays a subsidy via I.R.S. to the issuer to offset interest costs. Build America Bonds have democratized municipal finance. Unlike tax exempt bonds, which disproportionally help wealthy investor to avoid taxes, BABs provide an equal subsidy to all investors, regardless of their income. Build America Bonds are set to expire at the end of this month.

When BABs were enacted as part of the Recovery Act there was rare bipartisan support for the innovative program. Since then, all that we have learned is that BABs have been remarkably successful. State and local governments have issued $165 billion of BABs, greatly reducing their borrowing costs and expanding their access to investors. State and local governments have used BABs savings to create jobs and reduce taxes. Yet the bipartisan support has evaporated as some members of Congress are reluctant to give the President a victory by extending a successful Recovery Act program -- even though the idea has been around for 40 years.

The Recovery Act intentionally set the BABs subsidy at a high rate of 35 percent. This was done to encourage state and local governments to invest in capital projects during the worst part of the recession. The need for greater state and local government investment in infrastructure, as well as a large supply of unemployed construction workers, continues. In its budget, the Obama Administration proposed extending the BABs program and reducing the subsidy rate to 28 percent, a level at which the Federal government would not lose revenue from BABs as compared to tax exempt municipal bonds.

The availability of BABs has broadened the investor base for municipal bonds. Unlike tax exempt bonds, BABs are an attractive investment for low and moderate income investors, pension funds, philanthropies and foreign investors. The availability of BABs has enabled state and local governments to issue fewer tax exempt bonds, which has lowered their borrowing costs in the tax exempt market. If the BABs program is allowed to expire, state and local governments will issue more tax-exempt bonds, which will put upward pressure on their borrowing costs and reduce their investor base.

The criticisms levied at the BABs program do not hold up to scrutiny. Underwriting fees have come down over the life of the program as competition has increased. BABs have not subsidized some states at the expense of others, because BABs are principally an alternative to tax exempt bonds, which entail subsidies through foregone tax revenue. Foreign investors would have bought other taxable bonds, such as corporate bonds or Treasuries, so there is no revenue loss from them. And BABs have not caused a state and local government debt binge. If anything, BABs have provided a less risky, less costly and more transparent longer term borrowing instrument.

At a time when sovereign credit markets in Europe are again under extreme stress, it would be irresponsible to allow the BABs program to expire. BABs are a more efficient, more transparent and more fair way of supporting state and local governments' borrowing needs than traditional tax exempt bonds. Extending BABs at a revenue neutral subsidy rate would support state and local governments to carry out crucial investment projects, reduce the risk of a municipal bond market meltdown, and provide investment opportunities for all classes of investors -- all at no additional cost to federal taxpayers. An extension of BABs should be part of any compromise worked out over extending other tax cuts.

Alan B. Krueger is the Bendheim Professor of Economics and Public Affairs at Princeton University, and was Assistant Secretary for Economic Policy and Chief Economist at the U.S. Treasury Department from February 2009 until November 2010.