The Build America Bond program is likely to be extended for one year at something less than its current 35% federal interest cost subsidy level, due to the dynamics shaping up around the tax-cut extension Congress will consider when it returns after Thanksgiving.

Several sources said if an agreement can be reached on the larger question of the extension of the current, Bush era tax rates, then a tax bill will pass in the lame duck session and it is very likely to include extension of BABs and other municipal bond provisions from the American Recovery and Reinvestment Act that are otherwise set to expire.

Sources close to several senators acknowledge that the extension of Bush-era tax cuts is so important to Republicans that they would not hold up its passage in order to block a BAB extension.

Late Tuesday, Jill Gerber, a spokeswoman for Sen. Charles Grassley, the ranking minority member of the Senate Finance Committee, confirmed that Grassley “predicted yes,” that the BABs program would be extended.

He predicted this because the package also includes many popular tax provisions and has support from key Democrats in Congress, she said.

An aide to Sen. Orrin Hatch, R-Utah, indicated that the content of the tax extender measure is up to Democrats. Antonia Ferrier, spokeswoman for Hatch, deferred to Senate Finance Committee Chairman Max Baucus, D-Mont., because “he’s the one making those decisions.”

Ferrier added that Hatch “would rather it not be” extended, “but that’s not up to him.”

Hatch is expected to take over from Grassley as the ranking Republican on the Senate Finance Committee in the next Congress.

Baucus in September proposed legislation to extend several expiring or expired bond and tax provisions that includes a provision that would extend BABs through 2011 at a 32% subsidy rate. That’s half as long as comparable legislation introduced in the House, which would continue the program for two years and provided a 32% subsidy rate for BABs issued in 2011 and a 30% rate for those sold in 2012.

Both bills also would extend by one year several other stimulus provisions set to expire at the end of the year, including increasing the small-issuer exemption for bank-qualified bonds to $30 million from $10 million, the alternative minimum tax exemption for all tax-exempt bonds, and the two recovery zone bond programs.

A Democratic Senate aide Tuesday night indicated that the Senate could have a draft tax bill, including the one-year BAB extension at “32% or less” and an extension of the higher bank-qualified limit, as early as Dec. 1, but noted that it could take until Christmas Eve for a vote.

The dynamics for passage of a tax extenders bill this year will revolve around issues outside of the municipal market including the debate about what of the Bush-era cuts are to be extended and for what groups of taxpayers. One source indicated that Grassley’s support for extension of ethanol tax credits, which are important to his constituents in Iowa, could help Democrats keep him from blocking extension of BABs, despite his criticism of the program.

“He is going to have to give some skin,” one source said.

Grassley last week asked the Government Accountability Office to analyze BABs and determine who primarily benefits from the program, whether states are using the bonds to reduce budget deficits, and what federal agencies are finding in probes of BAB transactions. 

Such studies can take a year or longer and anything resulting from his request is not likely to be available before the BAB program is set to expire on Dec. 31.

The extension of BABs and other municipal bond-related tax provisions will be a small part of any tax bill that includes extension of the tax cuts, which one source said would be a “$4 trillion bill.”

The Joint Tax Committee in March estimated that expanding and making permanent the BABs program, as President Obama proposed in his budget, would cost a total of almost $2 billion through 2015 and $8.4 billion through 2020. A one-year extension at 32% would presumably cost less.

The JTC said a one-year extension of a pair of ARRA provisions that encourage banks to invest in tax-exempt debt would cost $2.96 billion over 10 years.

The first provision increases to $30 million from $10 million the small-issuer limit for bank-qualified bonds, and allows the limit to be applied to individual borrowers participating in conduit deals, rather than the conduit issuer. The second modifies the 2% de minimis rule for financial institutions to include banks. Under that provision, financial institutions that invest in tax-exempt bonds can deduct 80% of the cost of buying and carrying tax-exempt bonds to the extent that their tax-exempt holdings do not exceed 2% of their assets.

Through the end of October, municipal bond volume continued to reflect the theme of decreasing tax-exempt issuance as BAB issuance has increased. State and local governments borrowed $11.2 billion last month through the BAB program — the third-largest monthly total in its 19-month history, according to data from Thomson Reuters.

Tax-exempt issuance totaled $25.7 billion in October, or 15% less than the same month in 2009.

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