Existing Public Bonding Options
Existing public bonding options include tax-exempt bonds, private activity bonds, and taxable bonds.
Traditionally, state and local governments, as well as certain other nonprofit organizations such as universities and hospitals, have had the ability to issue debt for capital expenditures in the form of bonds. Bonds are debt instruments issued by a state or local government (or another eligible entity or instrumentality) that are either sold in the public market, placed with investors by an investment banking firm, or purchased directly by a bank. If the bonds are issued for a specified public purpose, the bond purchasers do not have to pay federal income tax on the interest income received from those bonds, as long as certain tax rules are met. Such bonds are referred to as tax-exempt bonds. Interest on the bond may also be exempt from state and local income taxes. As a result, tax-exempt bonds historically carry an interest rate to the borrower that is lower than comparable taxable debt.
Tax-exempt bonds could be used by a government entity to fund the capital expenditures for energy efficiency improvements in public buildings, but could not, in most cases, be used to fund privately owned energy efficiency upgrades on private residences or businesses.
Private Activity Bonds
Although tax-exempt bonds typically may not be issued for the benefit of private parties (i.e., the proceeds may not be loaned to private parties or used for a private purpose), there are limited exemptions to this rule. Exemptions include various “exempt facilities” that may be owned by private parties, including solid waste disposal and recycling facilities undertaking a public function, even if privately owned. Such bonds are referred to as private activity bonds, or PABs. In addition to the traditional categories of PABs, the Recovery Act created other types of bonds including Recovery Zone Facility Bonds and Qualified Energy Conservation Bonds. They and other similar instruments are similar to tax-exempt bonds and may be used for the benefit of private parties under certain conditions. Examples of those types of bonds are described in more detail in Section B below.
The same entities that may issue tax-exempt bonds for capital expenditures for public purposes may also issue taxable debt for private purposes. For example, a municipality could issue bonds to provide funds that are then lent to private individuals to fund energy efficiency improvements to private property. In such a case, the bond purchasers would be subject to the payment of federal income tax on the interest income received from those bonds.