Mid-summer, I wrote that the city of Newport Beach intended to use Build America Bonds (BAB) to finance the new City Hall project, and that in doing so the city was increasing the size of the federal deficit because the federal government subsidized 35% of the interest payments on BABs. In response, Mayor Keith Curry indicated that I was wrong because the federal government assumed that its 35% interest rate subsidy would be repaid because buyers of those bonds would pay income tax on the taxable interest paid on BABs.
At its Nov. 9 City Council meeting, the city approved issuing bonds totaling nearly $128 million to pay for the new City Hall project, much of which are BABs. At that same meeting, the council approved a budget amendment, which provided for a federal government payment to the city for a "2010 Federal BAB Subsidy" of $1,263,175. That is the first year of federal BAB interest payments to the city, which continue over the 30 year repayment period for these Newport Beach BABs.
On Nov. 22, 2010, in its opinion section, The Wall Street Journal stated, "... The Obama administration responded with a new kind of taxable bond that offered a 35% federal subsidy on the interest rate. Washington designed the subsidy to appeal to investors such as pension funds and overseas buyers who don't buy traditional municipal bonds because they can't take advantage of their tax-free status."
They don't take advantage of that tax-free status because pensions and foreign investors don't pay income taxes. And without payment of income taxes back to the federal government, the federal government increases its own debt because that 35% federal interest subsidy is not paid back to the feds.
The article also states, "The governments that have made the most use of BABs have been those with the greatest fiscal problems. The biggest issuer of BABs, California, has relied on an unprecedented number of gimmicks to balance its books in the last two years, such as temporarily increasing tax withholding rates and issuing IOUs to vendors."
Why is this important? Because if Newport Beach, a politically conservative area, takes such a multimillion-dollar federal subsidy, notwithstanding its impact on the federal deficit, which interest subsidy the city does not need because of the city's stellar credit rating, there is little real prospect for cutting the federal spending and the federal deficit.
Cutting is always hard, if not impossible, to do when the federal government is handing out money, and the obvious answers for the benefited party are, "Why wouldn't we: it's legal; if we don't someone else will; and the federal deficit is not my problem."
But it is your problem, Newport Beach, and you just added to the long-term stack of Federal I.O.Us that no one wants or intends to deal with, especially when you did not need to use those BABs and its federal interest rate subsidy in the first place.
John Heffernan is the former mayor of Newport Beach