On September 14, 2012, the federal Office of Management and Budget (“OMB”) released a report to Congress regarding the implementation of certain provisions of the Budget Control Act of 2011 (the “2011 Budget Control Act”). Among other matters, the report sets forth a breakdown of exempt and non-exempt budget accounts and estimated funding reductions for federal fiscal year 2013 across non-exempt accounts that may be required if budgetary “sequestration” is implemented. In particular, the report includes federal fiscal year 2013 reductions in the federal government’s subsidy payments, also known as “direct pay subsidies,” for interest on build America bonds, qualified zone academy bonds, qualified school construction bonds and qualified energy conservation bonds (collectively, “direct pay bonds”).

The 2011 Budget Control Act required the Joint Select Committee on Deficit Reduction (the “Committee”) to propose, and for Congress to enact, a plan to reduce the federal budget deficit by $1.2 trillion over a ten-year period. The Committee, however, failed to agree on a proposal, and to date Congress has not enacted a reduction plan. As a result, under the terms of the 2011 Budget Control Act, a budget “sequestration” is scheduled to go into effect on January 2, 2013, unless Congressional action is taken prior to that date to avert the sequestration.

Sequestration is a system of automatic, across-the-board cuts to federal spending in designated agencies and programs. Various statutory provisions establish exemptions for certain programs (such as the Medicaid program and most federal aid for highways) and set forth specific allocations of reductions for defense and non-defense spending. According to the OMB report, in the case of direct pay bonds, a 7.6% cut will be made to direct pay subsidies in federal fiscal year 2013 if sequestration is implemented. As an example, in the case of a build America bond with respect to which an issuer would otherwise receive a 35% direct pay subsidy, this would mean that the subsidy would be reduced to an effective rate of 32.34% for federal fiscal year 2013.

According to the OMB report, all of the estimated reductions, including those for direct pay subsidies, are preliminary, and the actual reductions may differ from those indicated in the report as a result of changes in law and ongoing legal, budgetary and technical analysis. It is unclear at this point whether sequestration will in fact be implemented for federal fiscal year 2013 and whether subsidies for direct pay bonds will be affected for fiscal years following 2013.

The OMB report can be found at: http://www.whitehouse.gov/sites/default/files/omb/assets/legislative_reports/stareport.pdf.

The total dollar amount of the proposed reductions for federal fiscal year 2013 is approximately $109 billion, of which approximately $322 million is allocable to reductions in direct pay subsidies. It appears likely that sequestration, if implemented, will adversely affect state and local government finances in different ways, depending upon their particular circumstances. The effects will be both direct as federal outlays for various programs are reduced and indirect to the extent decreased economic activity results from the sequestration process.

Lawyers in the Public Finance Department of Edwards Wildman Palmer LLP are actively monitoring developments relating to federal budget sequestration. Please feel free to contact the Edwards Wildman lawyer responsible for your public finance matters or one of the authors linked below if you have any questions regarding this topic.