As part of the White House’s $3.8 trillion 2011 budget, President Obama has proposed making the “Build America Bonds” program permanent. Build America Bonds have offered states and localities a quick fix since Washington created them in the stimulus package last year. But access to the bonds discourages municipalities from addressing their budget problems head-on, so that they can cut borrowing, not add to it.

Under the program, states can issue taxable bonds, with the federal government subsidizing the extra cost. The new proposal would cut the feds’ subsidy to states and localities from enough to cover a 35 percent tax rate to enough to cover a 28 percent tax rate.

Making this program permanent is a bad idea. Signals from the municipal bond market should be telling states and cities that they need to borrow less, not more. Washington is adding noise to these signals by offering up a huge new investor base — all investors who have to pay federal taxes — to state and city borrowers.

Plus, the program allows states and cities to circumvent an important part of market surveillance. Traditional investors in muni bonds and their intermediaries often keep a close eye on the finances of the municipalities in which they are investing. By contrast, a wealthy investor in Monaco who puts his money in a taxable muni bond has no interest in such matters; he only figures that if a big American state or city gets into enough trouble, the White House will bail it out.

There are reports that the Build America expansion will offer an even more egregious short-term benefit to states and cities at the expense of long-term fiscal and economic health: the ability to borrow for short-term operating costs, in addition to long-term capital investments. I couldn’t find this language in any of the budget documents. The most specific language I found (on page 1047) was that “The 2011 Budget proposes a revenue-neutral extension of this program,” but I’ll keep looking.

Obviously, such an expansion of the boundaries of the Build America program would be ill-considered, took, as it would federalize the practices that helped get New York City into trouble in the Seventies. So, if you hear more about it, be wary.

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