In March I wrote about how Florida had suspended its issuance of Build America Bonds because of concerns that the IRS could, and would, reduce the BAB subsidy if the municipality owed the IRS for separate, unrelated, issues (See Link).

Well, as reported yesterday by Bloomberg (See Link), the City of Austin is finding out the hard way that the IRS fully intends to exercise its ability to garnish BAB subsidies.  In February, Austin received a letter from the IRS stating that the IRS would be withholding $617,284 from the March 1 payment.  Luckily, Austin was prepared to transfer funds from a reserve account and continue to make the payments to bond holders.  The City continues to negotiate with the IRS over additional payments and may have more withheld from the next payment.

Since their inception, US municipalities have issued over $105 billion of Build America Bonds to the point where they represent the fastest growing segment of the municipal bond market.  The IRS’ willingness to withhold portions of its subsidy is very troubling.  While it appears that Austin and the IRS had been negotiating the withheld amount for some time and knew this was coming, the City of Los Angeles only found out about its reduction in payment when they performed an internal audit.  Fortunately, their’s was a small amount – $28.

As the use of BABs continues to grow, how long is it before the IRS withhold a subsidy from a locality that can’t afford to make up the difference for bond holders?  Or an even scarier thought, how long before the government decides it has the right (and obligation) to withhold BAB subsidies until the locality fully funds it pension plan!?!  Nothing good, for the locality or the bond holder, comes from this…

Shortly after President Obama signed the healthcare reform legislation into law, several states have filed lawsuits because the new Medicaid requirements will potentially bust their budgets.  So, what does this have to do with Infrastructure?

To begin with, anything that strains the state or municipal budget will limit their ability to fund new projects.  That’s not good news.  But, there is another tie in here that will severely limit localities access to capital.

As I mentioned a few days ago, Florida suspended its issuance of Build America Bonds (BAB) because of the potential that the IRS would reduce their subsidy amount by any amounts owned from other programs.  The new healthcare reform will significantly increase the costs to the states for Medicaid expenses.  If they are unable to cover the increased costs, the IRS will start taking from their BAB subsidy to get whole.  That puts even more pressure on the states and compounds the issue.  Florida estimates that the new healthcare reform law will add $1.6 billion of Medicaid expenses and force them to hire an additional 1,000 employees.  That’s $1.6 billion that they won’t have available to build schools, maintain roads, or repay bonds.

In a time when the states and municipalities are being hit financially as hard as ever, I struggle to understand the rational behind increasing the burden on them.  Maybe someone can explain it to me…

Bloomberg ran an article (see link here) this week about how the state of Florida has temporarily suspended the issuance of Build America Bonds due to a potential glitch in the refunding mechanism.  For those that aren’t as fmailiar with the Build America Bonds, or BABs as they are known, they are a product of the ARRA Stimulus legislation and represent the fastest growing segment of the $2.8 trillion municipal debt market.  The BABs are unique in that they are issued as taxable bonds with taxable equivalent yields, yet the issuing locality receives a refund from the IRS equal to 35% of the interest costs.  This, effectively, makes the cost to the issuer on par with tax free options.

Florida, however, has some concerns about how that 35% subsidy will be paid and has put its $255 million upcoming issuance on hold.  In a recent call with the Internal Revenue Service, the IRS reiterated that any subsidy due to the locality will be reduced by any amount that the issuer owes the federal government for other programs, including Medicare.  This is not a new provision of the BABs and has been a condition since their inception.  However, many of the localities are just now catching on to the fact that they may not get the full subsidy they have been expecting.

This becomes especially relevant as Congress seeks to pass the Healthcare Reform that could dramatically increase an issuers payments to the federal government for Medicare and similar type programs.  Should an issuer not be able to make its Medicare payments, the IRS will still get “theirs” through the BAB subsidy, leaving the locality in a death spiral of interest obligations.

According to the article, the largest issuer of BABs, California, is aware of the IRS claw-back provision and is continue to utilize BABs as a viable funding source.  It will be very interesting to see how many other states join Florida in taking a wait and see attitude.

The Navy this week announced that it has decided to home port a carrier at Naval Station Mayport in Florida.  Currently, the entire carrier fleet is stationed at Naval facilities in Hampton Roads.  The Navy’s motivation behind the move is to diversify the fleet and prevent a Pearl Harbour type incident from diminishing our retaliatory abilities.

The decision was met with significant opposition from Virginia lawmakers who vow to continue the fight to keep the carrier fleet in Virginia.  They claim that this is a politically motivated last minute effort by the Bush administration to push this through before they leave the office.  Consequently, they have begun to pressure the incoming Obama administration to reconsider the decision.  As you would expect, Florida lawmakers support the decision and call it critical to the security of America.

To compound the issue, the decision comes at a time when the Naval has its own budgetary issues to contend with and moving a carrier isn’t cheap.  In the five years that it will take to complete the move, the Navy would have to spend over $550 million to prepare the Mayport facility and channel for a ship of this size.  In addition, it will remove 11,000 jobs and $600 million in annual income from the Hampton Roads economy.

If the safety of the fleet is truly the primary concern, I would think the $550 million could buy some significant surface to air defenses for the Hampton Roads area.  Plus, any spending on protecting the fleet in its current location could be allocated across the entire fleet, not just one carrier.