Several recent legislative proposals call for the issuance of tax credit bonds, a form of debt financing that significantly subsidizes the borrowing cost of the project sponsor (debt issuer) by having the federal government pick up part or all of the interest expense through the provision of tax credits to the investors. This is accomplished through the issuance of hybrid debt instruments where the lender receives an annual return in the form of federal tax credits, in lieu of cash interest payments, plus return of principal at bond maturity. The borrower is responsible for repaying the principal from local revenue sources. The investor can apply the tax credits against its other federal tax liability. Since interest expense on long-term bonds may constitute as much as 75 percent of the financial cost of debt service in today's market environment, tax credit bonds provide the borrower (project sponsor) with a much deeper subsidy than do tax-exempt bonds.7
The potential efficacy of such proposals depends critically on how these bonds would be issued and what purposes their proceeds would fund. In general, the least expensive and easiest way for the federal government to raise capital is through Treasury's general borrowing programs. In the Commission's view, therefore, raising capital through direct federal issuance of tax credit bonds does not make sense.
Alternatively, proposals involving the issuance of tax credit bonds by state and local governments (or possibly other non-federal entities) may be an effective way to subsidize the cost of certain investments with public benefits. Existing programs of this type include the Qualified Zone Academy Bond program to help state and local governments finance public school modernization projects in low-income areas; the Clean Renewable Energy Bond program to promote investment in hydroelectric, solar, biomass, and other alternative energy sources; and the Qualified Energy Conservation Bond program to help finance renewable energy research and development and various energy conservation projects. These programs require bond principal to be repaid by the non-federal issuer from project-related or other nonfederal revenues. Recent testimony by various tax policy experts indicates that these types of programs can be effective and may be acceptable if the subsidy is carefully targeted and if they generally are subject to the same tax code restrictions as other "tax preferred" products like tax-exempt government and private activity bonds.8
Tax credit bonds could increase the funds available for infrastructure investment should policy makers determine that this deeper form of tax subsidy is desirable to help finance national- interest infrastructure. Any such tax credit bond programs, however, must be carefully targeted and consistent with established public policy objectives.