Tax Credit Bonds: Overview and Analysis

Steven Maguire
Specialist in Public Finance

Almost all state and local governments sell bonds to finance public projects and certain qualified private activities. Most of the bonds issued are tax-exempt bonds because the interest payments are not included in the bondholder’s (purchaser’s) federal taxable income. In contrast, Tax Credit Bonds (TCBs) are a type of bond that offers the holder a federal tax credit instead of interest. This report explains the tax credit mechanism and describes the market for the bonds.

There are a variety of TCBs. Qualified zone academy bonds (QZABs), which were the first tax credit bonds, were introduced as part of the Taxpayer Relief Act of 1997 (P.L. 105-34) and were first available in 1998. Clean renewable energy bonds (CREBs) were created by the Energy Policy Act of 2005 (P.L. 109-58) and “new” CREBs by the Emergency Economic Stabilization Act of 2008 (EESA P.L. 110-343). Gulf tax credit bonds (GTCBs) were created by the Gulf Opportunity Zone Act of 2005 (P.L. 109-135). Authority to issue GTCBs has expired. Qualified forestry conservation bonds (QFCBs) were created by the Food, Conservation, and Energy Act of 2008 (P.L. 110-246). Qualified energy conservation bonds (QECBs) and Midwest Disaster Bonds (MWDBs) were created by the Emergency Economic Stabilization Act of 2008 (P.L. 110-343).

The American Recovery and Reinvestment Act of 2009 (P.L. 111-5, ARRA) included several bond provisions that use a tax credit mechanism. Specifically, ARRA created Qualified School Constructions Bonds (QSCBs) and a new type of bond that allows issuers the option of receiving a federal payment instead of allowing a federal tax exemption on the interest payments. These new bonds, Build America Bonds (BABs) and Recovery Zone Economic Development Bonds (RZEDBs), are also unlike other tax credit bonds in that the interest rate on the bonds is a rate agreed to by the issuer and investor. In contrast, the Secretary of the Treasury sets the credit rate for the other TCBs. The authority to issue BABs and RZEDBs expires after 2010.

Each TCB, with the exception of BABs, is designated for a specific purpose or project. Issuers use the proceeds for public school construction and renovation; clean renewable energy projects; refinancing of outstanding government debt in regions affected by natural disasters; conservation of forest land; investment in energy conservation; and for economic development purposes.

All of the TCBs are temporary tax provisions. The QZAB and QSCB credit rate is set at 100% and the new CREB and QECB credit rate is set at 70% of the interest cost. In contrast, the BAB tax credit rate is 35%. The most recent version of H.R. 4213, which passed the House on May 28, 2010, would extend BABs through 2012, but reduce the credit rate to 32% in 2011 and 30% in 2012. The cost of the extension is estimated at just over $4 billion over 10 years. On July 28, 2010, Representative Levin introduced H.R. 5893, which mirrors the BAB extension as provided for in a version of H.R. 4213 (H.R. 4213 was eventually passed with only an extension of unemployment benefits as P.L. 111-205). In addition, H.R. 5893 would expand RZEDBs with a modified allocation formula with an additional $10 billion. On September 16, 2010, Senator Baucus introduced the Job Creation and Tax Cuts Act, which extends BABs through 2011 at a 32% credit rate and makes an additional allocation of RZEDBs.

In the FY2011 budget, the Obama Administration has proposed extending the BAB program at a lower direct payment credit rate of 28%. The reduced credit rate is intended to minimize the cost to the Treasury.


Date of Report: September 17, 2010
Number of Pages: 16
Order Number: R40523
Price: $29.95

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