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Key Points


·     The proposal would give state and local governments authority to issue $25 billion in federally-subsidized or tax-preferred bonds to encourage increased economic activity within depressed areas.

·     The proposal would allocate $10 billion for recovery zone development bonds and $15 billion for recovery zone facility bonds; governments would have to issue all bonds in 2009 or 2010.

·     The bonds must support economic development within recovery zones, defined as areas “having significant poverty, unemployment, home foreclosures, or general distress” or those areas classified as an empowerment zone.

·     Allocation of new lending authority among the states would be based on 2008 employment losses; states would generally apportion authority among counties and municipalities based on employment declines. Each state would receive at least 0.9 percent of the total allocation.

·     The provision is well-targeted to regions most adversely affected by the economic downturn, but is unlikely to quickly inject new capital into the economy or to generate significant new demand for investment. 

·     JCT estimates these provisions will cost $5.4 billion over 10 years.


Current Law

State and local governments may issue unlimited amounts of tax-exempt bonds for “public” activities, but they face limits on tax-exempt bonds that finance qualified private activities (when the government is essentially acting as a conduit between lenders and private industry). Because investors pay no tax on these bonds, municipalities can use them to borrow at lower interest rates than apply to taxable bonds with similar risk.

The Taxpayer Relief Act of 1997 created tax credit bonds (TCBs), which give investors tax credits in place of interest payments. A bondholder may claim the credit—which is a percentage of the bond’s face value—for a specified period after purchasing the bond. Examples of TCBs include Qualified Zone Academy Bonds and Clean Renewable Energy Bonds.

The tax credits for TCBs are taxable income for bond owners and the credit rate must therefore exceed the interest rate paid on tax-exempt municipal bonds. The Treasury Department determines TCB credit rates, setting them at a level that makes TCBs competitive with comparable types of bonds.   

Stimulus Bill:

The stimulus bill would give states and municipalities authority to issue $10 billion in bonds for recovery zone development and $15 billion of tax-exempt private activity bonds for recovery zone facilities. The stimulus bill would also expand the availability and marketability of various types of governmental bonds—including the new recovery zone bonds—in a number of ways. For example, it would give states and municipalities authority to issue a new type of TCB where the tax credit received by the bond holder would be a percentage of the interest paid by the local government. For bonds issued in 2009 and 2010, the issuing authority could elect to receive the credit (which would be a percentage of the interest cost) itself; such a provision would subsidize the interest paid to the borrower.

The bonds, which authorities must issue before 2011, would have to be used for economic development within a “recovery zone,” defined as an area “having significant poverty, unemployment, home foreclosures, or general distress” or an area currently defined as an empowerment zone.

Borrowing authority would be allocated among states on the basis of relative job loss in 2008, with greater authority going to states that lost proportionately more jobs. Authority within each state would be allocated among metropolitan areas and counties station a similar basis. Each state would receive at least 0.9 percent of the aggregate allocation for each of the two types of bonds.


Increasing the ability of state and local governments to issue new tax-advantaged or subsidized debt could provide economic stimulus, but only slowly and at the cost of reduced investment elsewhere. It takes time to issue new bonds and the proposal would give state and local governments nearly two years to do so. As a result, much of the new funding would become available only after significant delay. Furthermore, even more time would elapse before the new capital would actually generate more economic activity.

In addition, it is unclear if the proposal would help impoverished areas, regardless of the time lag. Private-activity bonds introduce economic inefficiency into the bond market (Johnson 2007), either because the project would have been undertaken anyway or because the subsidized project draws capital away from more valuable activities.  The provision might therefore simply shift capital among projects without generating much or any additional economic activity. In general, direct spending on worthwhile infrastructure and investment projects would be much more effective in stimulating the economy.

Despite the drawbacks in design, the provision is well-targeted at those states and municipalities most in need of an economic stimulus. Because allocations of authorized bonds would depend on the number of jobs lost over the past year, the provision would channel funds to those areas most in need of stimulus. However, lost jobs does not guarantee the existence of worthwhile investment projects, and funding for investment is best evaluated on the merits of the investment, not the tax advantages.    

Grade: C-

Despite being well-targeted at states and municipalities most in need of economic stimulus, this provision would be unlikely to generate significant new investment and would likely shift funds away from investments funded by taxable borrowing. Direct spending could stimulate investment in depressed areas faster without drawing as many resources away from other activities. 

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