Kicking the Sequestration Can Down the Road
This past summer, I wrote a blog post showing how the sequestration rate, which reduces federal subsidy payments to issuers of “Direct Pay Bonds” (defined below), has generally been decreasing since the spending cuts enacted by the Budget Control Act of 2011 (“BCA”) began on March 1, 2013. As a reminder, sequestration refers to the automatic, across-the-board spending cuts that apply to many of the federal government’s programs, projects and activities. Issuers of “Direct Pay Bonds” (i.e., Build America Bonds, Recovery Zone Economic Development Bonds and all qualified tax credit bonds that were issued on a direct payment rather than a tax credit basis), who are entitled to receive federal government subsidies tied to the interest paid on these bonds, have been negatively impacted by these spending cuts. The higher the sequestration rate, the lower the subsidy.
On the effective date of the BCA, the sequestration rate was 8.7%, and it is 6.6% for the federal fiscal year ending September 30, 2018. At the time of my last blog post on this topic, sequestration as applied to Direct Pay Bonds was set to expire on September 30, 2025.
The most recent budget deal, the Bipartisan Budget Act of 2018 (the “2018 Budget Act ”), enacted on February 9, 2018, makes temporary changes to the BCA. For example, the 2018 Budget Act temporarily suspends the statutory limits that were placed on certain categories of defense and nondefense/domestic spending by the BCA from February 9, 2018 through September 30, 2019 (the “Free Lunch Period”). The Free Lunch Period applies to “discretionary” spending. Unfortunately, the federal subsidy granted to issuers of Direct Pay Bonds is characterized as “direct” or “mandatory” spending rather than discretionary. Thus, sequestration applies unabated to Direct Pay Bonds, which means that issuers of Direct Pay Bonds get no free lunch during the Free Lunch Period.
What happens when the Free Lunch Period ends on October 1, 2019? Sequestration will once again apply to discretionary spending, because the BCA will still be the law, and the temporary override provided by the 2018 Budget Act will expire. Moreover, the 2018 Budget Act extends until September 30, 2027 the application of sequestration to direct/mandatory spending. In other words, Congress has stuck issuers of Direct Pay Bonds with some portion of the tab for the Free Lunch Period by “Kicking the Sequestration Can Down the Road” even further for these issuers.
*This post has been corrected to reflect the fact that the Free Lunch Period does not apply to Direct Pay Bonds.