Subsidizing Infrastructure Investment with Tax-Preferred Bonds

Report
October 26, 2009

The federal government supports infrastructure investment in a variety of ways. It spends money directly, makes grants to state and local governments for their capital spending and, through the tax system, subsidizes the borrowing of both of those levels of government as well as certain private entities to finance infrastructure projects. However, the most common means of providing a tax subsidy for infrastructure investment—by offering a tax exemption for interest on state and local bonds—is generally viewed to be an inefficient way to subsidize state and local borrowing, largely because the revenue cost to the federal government may exceed the interest-cost subsidy provided to state and local governments by a substantial amount.

To inform the Congress in its deliberations about federal infrastructure policy, this study assesses the role of tax preferences in infrastructure investment in the United States. It discusses the types of tax preferences for state and local bonds, reports the amount of such debt that has been issued for infrastructure projects undertaken by the public and private sectors, and estimates the importance of that debt financing to infrastructure investment. It also considers how the current system of tax preferences—which historically has relied primarily on tax exemptions for interest income on debt issued by states and localities—might change as a result of greater use of tax-credit bonds.