Private Capital Trumps Federal Money in Infrastructure Plan

Opinion

The outline of the Trump Administration’s infrastructure plan announced Monday has generated much initial reaction as infrastructure interests parse what can be best described as a framework of a plan. The general parameters of the plan offered were not surprising. They emphasize private sector involvement, federal asset sales, reduced environmental regulation, and a higher reliance on user based revenue.

An amount of spending – $1.5 trillion over ten years – was but a reinforcement of an effective 85% plus state/local share dampened state and local enthusiasm. Financing is not the issue for states and localities. They know how to finance these projects. The challenge is how to meet the need for funding. That is where the plan is likely to come up short.

The draft does not comport with recent legislative realities. It envisions the use of tax-exempt private activity bonds (PAB) and advance refunding of tax-exempts. PABs withstood a significant assault before being retained under tax reform but advance refundings were eliminated. So the draft is of limited use at best through its reliance on dated concepts. The reliance on the municipal bond market and in particular the use of PAB financing bolsters the administration’s bias toward the private sector as the chief provider and/or beneficiary financially of infrastructure funding It’s various provisions in terms of project selection and provision clearly weigh the criteria in favor of private entities. What was surprising was the provision that called for existing constraints on the use of municipal bonds to finance private activities to be loosened.

Notably, the draft proposes elimination of the alternative minimum tax (AMT) provision and the advanced refunding prohibition on. The plan also calls for elimination of the transportation volume caps on PABs and expands eligibility to ports and airports, removal of state volume cap on PABs, provision for change-of-use provisions to preserve the tax exempt status of governmental bonds, and provision of change-of-use cures for private leasing of projects to ensure preservation of tax-exemption for core infrastructure bonds.

Incentives for states to spend will be established under formulae weighted toward projects with private participation and there are limits on the percentage of federal funding. It seeks to loosen environmental reviews and encourages usage charges (tolls) to provide revenues for local shares. The end result is a program which generates benefits for the private sector while shifting much of the cost of these projects to the states and localities. The program also shows a misunderstanding of the difference between the two key concepts which should underpin any sound infrastructure plan – financing and funding.

When the average person talks about infrastructure they are almost always referring to what economists characterize as public goods. Public goods are designed to facilitate profit making economic activity. They are not inherently expected to generate a profit themselves. That is not to say that there is no role for the private sector. Private entities have shown that they can be more efficient and cost effective in the overall process of infrastructure development. The use of private entities to design and build significant facilities is increasingly evident. The three most recent major bridge projects in the New York metropolitan area were all efficiently and economically delivered through the use of design/build contracts with ownership of the assets retained by the governmental entity.

While not explicitly referenced, asset recycling where the sale or lease of existing facilities to generate toll revenue for funding of additional projects and profits for the private asset purchasers is likely a philosophical centerpiece of any plan . These assets would likely include highways, airports, and rail facilities. In the area of federal assets, the draft suggests several electric utility assets owned by the Federal government as examples of potential asset sales. Already there are significant water distribution systems which are owned and operated by private interests so a Trump infrastructure plan would seek to expand the role of private entities in these utilities.

In many ways the effort to involve more private providers is an effort to attract foreign investment especially foreign equity investment in American infrastructure. There are benefits to expanding the range of sources of capital. At the same time, the drawback to using equity investment directly or through foreign company service providers is that these investors seek higher rates of return than do traditional US municipal bond investors. A more mutually effective way to involve the private sector would be through accessing their existing designing and building abilities to deliver projects. A number of success stories have been accomplished while generating 10-12% returns.


 

“In many ways the effort to involve more private providers is an effort to attract foreign investment especially foreign equity investment in American infrastructure. There are benefits to expanding the range of sources of capital. At the same time, the drawback to using equity investment directly or through foreign company service providers is that these investors seek higher rates of return than do traditional US municipal bond investors.”

 


On the funding side, the draft raised many concerns on the part of state and local governments who will see increased funding responsibilities under the anticipated state and local/federal shares of the proposed trillion dollar plan. The allotted $200 billion comes from cuts to programs including the Transportation Investment Generating Economic Recovery (TIGER) grants and transit funds. The White House said it made the cuts where “infrastructure funds haven’t been spent efficaciously.” This will not please big city mass transit providers.

States and localities are encouraged to come up with more funds of their own while the tax code changes just enacted make it less attractive for taxpayers to support that choice. Grant awards can’t exceed 20% of total project cost. Any individual state can’t receive more than 10% of the amount available. A Rural Infrastructure Program designed to encourage investment to enable rural economies, facilitate freight movement, improve access to reliable and affordable transportation, accounts for 25% of total appropriation. States are incentivized to partner with local and private investment for completion and operation of projects under this program. This last provision tips the scales towards privately owned and operated systems.

The plan can be seen as constructive for bonds from the view of the financing side of the market but credit negative for the credit side of the market through its cost shift to the states. The debate has to start somewhere however, so now we at least have a starting point. The draft builds on support for relaxed PAB provisions as evidenced by the recent Warner-Cornyn bipartisan proposal just introduced. Their bill, the Building United States Infrastructure and Leveraging Development (BUILD) Act, will aim to lead to additional investment in infrastructure projects by allowing state and local governments to enter into additional public-private partnerships to finance surface transportation projects.

Whether the proposal when it is formally released can garner enough support is not clear. Upon release, the plan will face challenges. Rural areas will want greater support for things like broadband provision and expansion above the proportions envisioned in the draft. States will be disappointed that traditional cost sharing ratios will be less favorable. Let’s look at three examples of major infrastructure programs requiring massive capital investment. The prime example of this would be the much discussed Gateway Tunnel. The proposed funding ratios in the draft plan would shift even more of the cost of this clearly necessary project onto the taxpayers and fare paying public in New York and New Jersey even though the trains using it serve a much wider area.

High speed rail is another area of infrastructure with a fair measure of public support. In California, high speed rail has encountered opposition from some of the state’s congressional delegation who have strongly fought to obstruct any efforts at even indirect federal funding. Yet the only recent new high speed rail project to begin service (in Florida) fought long and hard for as much of a federal subsidy as it could get through the use of tax exempt municipal bonds. And finally, the Delta water tunnel project in California would provide water resources serving large swaths of the state and a variety of arguably national economic interests. High speed rail and projects like the Delta Tunnels do not seem to have an outlet in this program.

At its proposal, the Administration has made clear that the document is the mere starting point for negotiating legislation. In favor of passage is the fact that infrastructure does have bipartisan and widespread regional support. At the same time, the funding of the plan through the elimination of some popular existing mass transit funding sources will make it harder to drive a bargain. The adopted plan will be far different than what we see in this effort.

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