See also: Why We Need a Permanent Build America Bonds Program by Jordan Eizenga
This December will mark five years since Congress passed the Gulf Opportunity Zone Act of 2005 in Hurricane Katrina’s wake. The legislation was designed to promote the redevelopment of damaged parts of the Gulf Region (the GO Zone) by providing tax incentives to invest there. Most notably, the GO Zone Act provided an additional $7.8 billion, $4.8 billion, and $2.2 billion in private activity, tax-exempt bonds—GO Zone bonds—to Louisiana, Mississippi, and Alabama, respectively. Particularly in New Orleans, these bonds are not working as they were intended and policymakers shaping redevelopment efforts following the gulf oil spill should study these bonds closely to see if better options exist for encouraging economic recovery.
A quick note on bonds. A bond is just like a loan: The buyer of the bond is lending money to the issuer and, in return, receives interest on that loan. This means the buyer is the lender and the issuer is the borrower.
The GO Zone bonds were initially seen as a promising way to promote investment in some of the most damaged areas of the Gulf Region. They were supposed to enable private businesses in the GO Zone to borrow at very cheap rates. State governments allocate a certain amount of tax-exempt bonding authority to businesses to be used when they borrow.
A company with $100 million in tax-exempt bonding authority can issue $100 million worth of bonds whose interest income is not subject to federal income taxes. Since buyers of tax-exempt bonds do not have to report interest income from the bonds as federal taxable income they should be willing to buy the bonds at lower interest rates.
New Orleans, which suffered the largest capital losses from Hurricane Katrina, has seen a dearth of GO Zone bond financed activity since the legislation created the bonds in 2005. In fact, $750 million of the $1.3 billion of bonding authority set aside for the 13 most damaged parishes in New Orleans was returned to the state bond commission after developers failed to place the bonds with investors.
These funds were re-allocated to less damaged parts of the region and to development projects that would likely have been viable without the tax exempt bond authority. Exxon Mobil announced in June, for example, that it would be using $300 million of GO Zone bonds to upgrade an oil refinery in Baton Rouge. Clearly it would have been better to simply retire unused bonds than re-allocate them to projects that don’t merit their use.
GO Zone bonds demonstrate the difficulties of using tax-exempt bond financing to direct investment to the most depressed regions. The bonds offered some of the most advantageous financing terms to local developers, but they still require a buyer willing to finance a project in an extremely distressed area.
Perhaps in the case of New Orleans-based projects, the perceived risk of investing in the city often outweighed the tax benefits of doing so. New Orleans developers’ difficulty placing GO Zone bonds may have also been exacerbated by the downturn in the credit markets as a result of the financial crisis. This is one risk of using tax-exempt financing to drive economic development efforts in already high-risk regions.
Policymakers should re-examine how effective tax-exempt bonds are in driving economic development given the need for further redevelopment in the gulf region following the oil disaster. Evidence of the past five years shows that the bonds did not work as they were intended even though the exact reasons are unclear.
This suggests that other mechanisms less reliant on private investment could be more successful in stimulating redevelopment efforts in highly damaged areas. A public works program, for example, may be a more effective use of taxpayer dollars. Rather than provide $1.3 billion of tax-exempt bonding authority to New Orleans and incur approximately $140 million in foregone tax revenue the federal government could use those dollars to put people to work on local redevelopment projects.
This is only one idea and there will certainly be many others. Policymakers should give each careful consideration. After all, it would be a shame to repeat the mistakes of the past five years.
Jordan Eizenga is a Policy Analyst with the Economic Policy team at American Progress.
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