WASHINGTON - The federal subsidy payments to issuers of Build America Bonds and other direct-pay bonds will be cut by 6.8% in fiscal 2016, which begins on Oct. 1, under sequestration, the Internal Revenue Service announced.
The cuts will apply to subsidy payments processed on or after Oct. 1, 2015 and on or before Sept. 30,2016 for BABS, qualified school construction bonds, qualified zone academy bonds, new clear renewable energy bonds, and qualified energy conservation bonds that were issued as direct-pay bonds, the IRS said.
The 6.8% sequestration for fiscal 2016 follows cuts of 7.3% in fiscal 2015 and 7.2% in fiscal 2014.
The sequestration amount for fiscal 2016 is lower because of Medicare and its growing costs, said Richard Kogan, a senior fellow at the Center on Budget and Policy Priorities. Sequestration calls for $109.3 billion of cuts equally divided between defense and nondefense programs. The resulting $54.7 billion for nondefense programs is divided between discretionary programs and entitlements like Medicare. Sequestration for Medicare is capped at 2% of its costs. So as Medicare costs rise rapidly, more of the $54.7 billion comes from entitlements than from the discretionary programs.
Sequestration has led many issuers of BABs and other direct-pay bonds to fall back on extraordinary redemption provisions in their bond documents that allow them to redeem their bonds. Many issuers of these bonds have announced to bondholders that they have the right to redeem their bonds, and some have followed through with actual redemptions.
The cuts have also soured issuers' interests in direct-pay bonds to some extent. State and local governments that issued taxable BABs in 2009 and 2010 were to receive subsidy payments equal to 35% of their interest costs from the Treasury. But the sequestration cuts have knocked down that percentage rate.
"It's good that the percentage is going down. However it should never have been imposed on direct-pay bonds to begin with," said Bill Daly, director of governmental affairs for the National Association of Bond Lawyers. "The application of sequestration has really hurt the acceptance of direct-pay bonds among issuers."
President Obama, in his fiscal 2016 budget request, proposed creating a permanent, taxable, direct-pay America Fast Forward bond program, with Treasury to make subsidy payments to issuers equal to 28% of their interest costs. The AFF program would be exempt from sequestration.
Dustin McDonald, director of the Government Finance Officers Association's federal liaison center, said, "We anticipate that Congress and the administration will both continue to offer proposals for new rounds of Build America Bonds or other BAB-like bonds.
He noted that many of these proposals will seek to exempt the bonds from sequestration. "But there's been no effort to mitigate the cuts already in put in place," he said, adding, "It's disappointing."
Sequestration began in March 2013. It was triggered by Congress' failure to reach agreement over how to significantly cut the deficit. The sequestration cuts were originally supposed to extend through fiscal 2021, but were extended, most recently through fiscal 2024 in February 2014. However, the formula changes over time.
