New Infrastructure Bond Act Offers 28% Federal Subsidy, Making Bond Interest Taxable

The American Infrastructure Bonds Act of 2025 is trying to tackle the massive infrastructure funding gap by introducing a new kind of financing mechanism. Essentially, this bill creates a direct federal subsidy for state and local governments—or other entities—that issue bonds to fund public projects like roads, bridges, and water systems. The goal is simple: make it cheaper for local governments to borrow money for big projects.

The 28% Discount on Borrowing

Here’s how the subsidy works: If a city or state issues one of these new "American infrastructure bonds," the federal government will pay them back 28% of the interest they owe on that bond, directly and automatically, every time an interest payment is due (SEC. 2). Think of it as the federal government picking up over a quarter of the interest tab on a local construction loan. This is a massive incentive designed to lower the net cost of borrowing for infrastructure projects, potentially leading to more projects getting off the ground sooner. The bill is clear that this direct payment to the issuer is protected from federal budget cuts (sequestration), which gives local governments certainty that this subsidy won't suddenly disappear.

The Taxable Trade-Off for Bond Holders

Now for the catch, and it’s a big one for investors and the finance world. Normally, interest earned on municipal bonds is tax-exempt at the federal level. That’s the whole appeal. However, for a bond to qualify for this 28% federal subsidy, the interest earned by the bondholder must be counted as taxable income for federal income tax purposes (SEC. 2). This is a fundamental shift. For the average investor, this means the interest they earn on these specific infrastructure bonds will be treated just like income from a corporate bond or a savings account when they file their federal taxes. While the bill specifies that states must still treat this interest as tax-exempt unless they pass a law saying otherwise, the federal tax change adds complexity and potentially reduces the appeal of these bonds to traditional municipal bond investors.

Who Pays and Who Benefits?

This bill sets up a clear exchange: state and local governments benefit from significantly lower borrowing costs, which could mean fewer delays on that new water treatment plant or highway interchange. However, the cost of this 28% subsidy is borne directly by the general federal taxpayer. Instead of offering an indirect subsidy through a tax break to the investor (as with traditional tax-exempt bonds), the government is now making a direct cash outlay to the bond issuer. This represents a substantial new commitment of federal funds to finance local infrastructure debt.

For the bond issuers—like your local water authority or state transportation department—this is a huge win. The savings on interest could be directed toward other local needs or simply reduce the overall cost of the project. But for the federal budget, this is a new, direct expense, shifting the financial burden of local infrastructure partially onto the national taxpayer base. This structure essentially converts a traditional tax-exempt financing tool into a federally subsidized, taxable financing tool, which is a major change in how public works are funded in the U.S.