WASHINGTON — A federal cap on tax-exempt bonds could gradually wean investors and issuers off the muni market and toward a permanent, expanded Build America Bond market that has a flexible subsidy rate, a new report from the Center for American Progress argues.

The 30-page report, released Friday and authored by Jordan Eizenga and Seth Hanlon, asserts that BABs are a better product than tax-exempt bonds, based on the inefficient nature of tax-exempt debt for the federal government.

The authors contend that greater efficiency in the municipal market can be achieved with two mechanisms: a cap on the tax-exempt market, similar to the federal cap for private-activity bonds, combined with a BAB subsidy rate that can be altered by Congress.

Wielding these two levers, Congress has “a viable way to stabilize the market in the short term, and strengthen [its] ­efficiency and potency,” the two authors wrote in the report.

BABs have “been tested and shown to work,” they said. “Given the immediate fiscal challenges facing all levels of government and the ongoing need for infrastructure investment, we should not let such a good idea go to waste.”

With a Congressionally-controlled BAB market, lawmakers can take the best aspects of BABs to crowd out the inefficient tax-exempt market.

The authors argue that Congress can tinker with the subsidy rate depending on economic conditions, offering “a less- or more-generous subsidy.” A BAB exentsion passed the House twice last year, but failed to overcome Republican opposition in the Senate. Sen. Jon Kyl, R-Ariz., claimed BABs allowed lower-rated issuers to sell bonds they might not have been able to afford in the tax-exempt market. Sen. Charles Grassley, R-Iowa, said he resisted a BAB extension because it would be too costly.

The Republican concerns that BABs are too expensive “are based on a meaningless accounting distinction” between a direct subsidy and a tax expenditure, the authors said.

“It makes no difference to the federal Treasury whether Congress spends money by collecting taxes and then writing a check, or by forfeiting tax revenue it otherwise would have collected,” they wrote.

The report also addressed the BABs cost concern by saying a different subsidy rate also could be set for different projects. BABs issued for transportation projects could merit a more lucrative subsidy than other projects, or vice-versa.

The need for BABs hinges on the inefficiency of the tax-exempt market, according to the report. One drawback to the traditional muni market is that tax-exempt bonds are an inefficient expenditure for the federal government.

“The federal government would get more bang for its buck if it simply gave money to state and local governments to spend on capital investments,” the authors wrote.

This inefficiency has been accepted for nearly a century of tax-exempt financing as munis have offered issuers viable access to credit.

But the financial crisis gave lawmakers a chance to experiment with the market. The American Recovery and Reinvestment Act of 2009 created BABs. The taxable bonds offered issuers two options: a direct-pay subsidy equal to 35% of their interest costs or a 35% tax-credit rate to be passed on to the investor. Not a single BAB was sold with the tax-credit option.

The success story of BABs is now well-known. The taxable securities issued by governments and nonprofits opened the traditional tax-exempt market to foreign investors and pension funds. BABs lowered borrowing costs for tax-exempt bonds by reducing supply and lowered interest rates on the long-end of the tax-exempt yield curve.

The strong success of the BAB market ultimately proved to be its downfall. Lawmakers complained it allowed issuers to take on more debt than they would otherwise. This added costs to taxpayers, they claimed.

These arguments are flawed,  Eizenga and Hanlon contend.

“Tax-exempt bonds and [BABs] are both spending programs,” they wrote.

When the BAB program expired, borrowing costs increased back in the traditional tax-exempt market.

“For deficit-wracked state and local governments, the demise of the [BAB] program could not have come at a worse time,” the report said.

For their plan to achieve textbook efficiency, Congress would take control of the municipal market and decrease the cost of inefficiency with the tax-exempt bond volume cap.

The plan also would bring more stability to the muni market because the two-pronged financing approach would give Congress flexibility to adjust the size of the tax-exempt market and the subsidies of BABs.