What do Alaska, Montana, Arkansas and North Dakota have in common?

They are the only states that are not struggling with a budget deficit this year.

No matter how they did it: reducing spending, making difficult cuts in services or personnel, not blowing a surplus they might have enjoyed in a previous year, they all have fiscally-responsible elected officials.

At the start of the 2010 fiscal year, the spending gap among the remaining 46 states exceeded $121 billion. In first place? California, with an $18 billion deficit- 15% of the total. By comparison, silver medalist New York, almost looks like a miser with  a paltry $8.5 billion deficit.(1)

Guess what?  No matter where you live, including Alaska, Montana, Arkansas, and North Dakota, you’re bailing them out.

Feeling all warm and fuzzy inside? Thank the fiscal stimulus package Congress passed last year.(2)As explained in a release issued by the U.S. Treasury, “Extraordinary challenges require extraordinary action by our government to ensure the economy gets back on track and that millions of Americans get back to work.”

Among the “extraordinary actions” was the introduction of so-called Build America Bonds.  Unlike traditional debt issued by states and municipalities, investors who purchase “BABs” must pay federal income tax on the interest they receive. To make sure cash-strapped local governments can afford to make those payments, the federal government is picking up 35% of the interest for the life of the bond. 

The idea was to reduce borrowing costs so that “much needed infrastructure projects can begin to revitalize our communities.”  As envisioned by Congress, these would include work on “public buildings, courthouses, schools, roads, transportation infrastructure… environmental projects, energy projects, government housing projects and public utilities.”

It was only supposed to be a temporary help, a two-year crutch to help cities and states get back on their fiscal feet.  The Congressional Budget Office [CBO] estimated it would cost the federal government $4.3 billion in interest over 10 years. 

However, human nature being what it is, what would you do if you had a rich uncle, let’s call him Sam,  picking up more than a third of the cost of your living expenses? 

Predictably, state and local officials have rushed to issue far more debt than imagined.  According to Dino Mallas, a portfolio manager in the municipal bond department at T. Rowe Price, as of last month, roughly $121 billion in Build America Bonds had been issued.

One-third of the total amount has been issued by entities in California and New York, according to Republican Sen. Charles Grassley from Iowa (2010 budget deficit of $102 million). This means that for those of us who live in the remaining 48 states, we subsidizing the budget excesses of these two (largely Democratic) states. 

Another Republican upset about the ballooning BABs program is Sen. John Thune of South Dakota (2010 budget deficit of $102 million).  A spokesperson says the federal government is now on the hook for $30 billion in BABs interest- seven times more than originally estimated.  And since the ability to issue BABs doesn’t run out until the end of this year, that number likely to increase considerably.

Build America Bonds have proven so popular with the folks back home that some members of Congress wants to extend the program another two years. (After all, there is an election coming up.) A bill already passed by the House would simply lower the federal subsidy from 35% to 32% next year and 30% in 2012.

Thune, Grassley and other Republicans in the Senate are trying to block that.

As I wrote last week, for U.S.-based investors BABs only make sense if you don’t need the tax-free interest that typical municipal bonds offer- perhaps because you’re buying them for a retirement account or you’re in a lower tax bracket. 

Most professional managers see BABs as a new asset class and are using them to further diversify taxable fixed income portfolios.  Eaton Vance’s Craig Brandon, manager of the only open-end BABs mutual fund, says the bonds offer a slightly higher yield than corporate debt.  He’s not overly-concerned about defaults, since municipal issues have historically had a low default rate.

Ironically, the investors who get the biggest bang for their bucks are headquartered outside the United States.  Foreigners- including pension funds, countries, and banks- don’t pay U.S. income tax.  As a result, they don’t have to send any of the interest- again subsidized by you and me- back to the federal government in the form of taxes. 

Great.  So now we’re not only underwriting spendthrift U.S.-based states and cities; the subsidized interest American taxpayers are paying to BABs issuers is going right into the pockets of foreign entities!

Thune, who supported a more limited use of BABs, calls the current Act “bad legislation.”  He’s introduced The Deficit Reduction and Budget Reform Act of 2010 which “takes a 3-pronged approach to reducing the rapidly-expanding burden of growing debt and deficits for American families and businesses.”  In addition to allowing BABs and other stimulus spending to expire as planned at the end of this year, it also calls for reforming the budget process and giving the president the line-item veto.

I’m giving away my age, but to quote a line from the movie “Network News,” I’m mad as hell and I’m not going to take it anymore!”

 

1. Click here to see where your state stands.

2. The American Recovery and Reinvestment Act of 2009.

 

"Ms. Buckner is a Retirement and Financial Planning Specialist at Franklin Templeton Investments. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content. 


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