By George D Friedlander, Executive Director, George Friedlander, and Associates
March 30, 2021
The planning, design, and implementation of a major, effective and efficient Federal infrastructure program is by no means an easy task. The administration has proposed an additional $3 trillion spending package, for improving infrastructure, fighting climate change, and reducing economic inequities.
These three goals overlap, in the sense that a significant portion of spending for infrastructure in the current environment will be used in conjunction with fighting the implications of climate change, and that large, aggressive spending of this type will provide additional construction-related jobs in the aftermath of the weak work environment generated by the pandemic.
The generation and design of a massive package such as this one will create great challenges in terms of:
- Project selection, in terms of project type, project location, and the magnitude of under-funding relative to optimal conditions;
- The extent of funding subsidy relative to the total cost of any given project; and,
- The relationship between funding needs and financing needs.
The case for this level of massive spending on infrastructure and related projects is compelling, related to underfunding of a wide range of types of projects since the Great Recession; the growing need for project spending as the nation begins to address climate change; the severe financial under capacity for state and local governments to fund needed projects without major Federal financial support; and, a rapidly changing economic environment as technological change leads to new components of infrastructure, such as electric charging stations and reduced reliance on carbon-based energy.
Indeed, we also expect technological change to generate new strategies for reducing the cost of needed infrastructure, and for improving its resilience and sustainability.
We believe a compelling case can be made for a quartile of enhancements to the municipal bond market that would improve the efficiency of financing projects in the current environment, utilizing techniques supported by a wide range of state and local government groups. This quartile includes:
- Reinstituting advanced refunding, which was eliminated in the 2017 tax law changes;
- Tripling of the maximum amount of bank qualified bonds per issuer, from $10 billion at present to $30 billion;
- Recreation of a subsidized taxable bond structure similar to the Build America Bond program that was highly successful during 2009-10 after the Great Recession; and,
- Separately, but in our view highly important in the current environment, an increase in the capacity for state and local governments to use private activity bonds: a combination of private financing, private design and construction, private management, and public ownership/tax-exempt financing to optimize financing for major, modern projects, such as the $6 billion planned transportation project recently announced in Maryland.
The issues involved in generating an effective program of this magnitude are vast and complex.
The start of the Biden proposal
The initial shape of an infrastructure proposal, combined with a number of other key Biden initiatives, is taking shape.
A pair of proposals would invest in infrastructure, education, workforce development, and fighting climate change, with the aim of making the economy more productive.
We note that the initial proposal also includes some additional provisions aimed at increased economic fairness, including free universal pre-K education and free community college.
As we define it, the term “infrastructure” is somewhat broader than that defined elsewhere. We consider infrastructure to include all capital facilities that are typically governmentally owned and/or managed, perform a governmental function and/or service, and help to enhance economic activity, either at present or over a number of years. Thus, under our definition, infrastructure includes all surface transportation, rail facilities, water, and wastewater facilities, mass transit facilities, waste disposal facilities, broadband projects, highway modernization such as for charging stations, and other similarly situated capital structures. We also note that infrastructure has a number of “cousins” that do not quite fit under this definition but play a complementary role: air pollution control facilities, and even K-12 school buildings.
As defined, an infrastructure plan would spend heavily on clean energy deployment and the development of other “high-growth industries of the future” like 5G telecommunications. It includes money for rural broadband, advanced training for millions of workers, and one million affordable and energy-efficient housing units.
The needs? Considerably greater than those estimated by many sources.
The Federal government is now facing a severe conundrum: the need for Federal support for infrastructure financing is vast and growing, even as the Federal government faces an annual and accumulated deficit of record proportions. We will set the deficit aside, as a policy and political issue beyond the question of need, and note that state and local government borrowing—a key source of capital facilities financing—has barely been growing.
Over the past 5 years, the amount of municipal debt outstanding, according to the Federal Reserve, has only grown by 4.0%, a compound annual growth rate of 0.8%. At the same time, support for infrastructure projects from the Federal government has been exceedingly modest—actually one has to look back to the Obama American Recovery and Reinvestment Act in 2009 to find a period of solid Federal support for Infrastructure projects, and even then the amount allocated was exceedingly small relative to current standards and needs. Under ARRA, $105.3 billion was allocated to infrastructure projects—and in addition, the bill provided support for state and local funding through the BABs program, which provided a 35% subsidy on debt issued on a taxable basis.
Since then, Federal support for state and local projects has been minuscule, even as demand from state and local governments has continued to grow. Also at the same time, the capacity of state and local governments to support state and local projects from not-debt sources, such as current budgetary spending, has not been growing. So, in the aggregate, spending from all sources for state and local capital projects has fallen farther behind.
Issues related to funding vs. financing.
In our experience, there has been considerable confusion regarding the distinction between financing and funding of state and local government projects, infrastructure or otherwise. Financing refers to the availability of investible funds for any project, and so long as a project is creditworthy — financing is nearly infinitely available.
Funding refers to the moneys needed to pay for a project, including up-front financial support for a given project, such as via a Federal grant, moneys available from the state, local or project sponsor, such as moneys in a highway trust fund or state highway authority, and revenues or taxes available to pay debt service on the borrowed component of the cost of a project. Given the near-infinitesimal magnitude of incremental moneys borrowed by state and local governments over the past 5 years, as shown in the Fed Flow of Funds, we would suggest that moneys available for infrastructure funding has been severely limited. In other words, since the capacity to pay debt service on bonds issued for state and local projects has been extremely limited, state and local governments simply haven’t been borrowing significant amounts for governmental projects.
The limitation hasn’t been on financing capacity, it has been on funding capacity. This, in our view, is where any upcoming infrastructure reconciliation bill would come in: given the extremely limited magnitude of moneys available at the state and local level to fund a vast magnitude of infrastructure projects, state and local governments are sorely in need of support for funding from Federal sources.
How would Federal subsidies related to a new infrastructure reconciliation project be disbursed?
We note that, as of the date of this paper, there was discussion of the development of a Federal Infrastructure package as large as $3 trillion. A pair of proposals would invest in infrastructure, education, workforce development, and fighting climate change, with the aim of making the economy more productive.
As a recent New York Times article notes, “President Biden’s economic advisers are pulling together a sweeping $3 trillion package to boost the economy, reduce carbon emissions and narrow economic inequality, beginning with a giant infrastructure plan that may be financed in part through tax increases on corporations and the rich.”
Our discussion here today will not focus on the means of paying for the program; our main concerns is this point relates to:
- Project selection—infrastructure sector, state or local government project manager–and timing and form of Federal funding.
- The magnitude of Federal subsidies relative to the size of various potential projects.
Project selection and timing, and the identification of the magnitude of subsidies per project are by no means easy tasks. Clearly, the variety of different projects that can be funded in part through Federal subsidies is vast and varied. The magnitude of the subsidy relative to project costs is also a challenge: if the subsidy is too great as a proportion of potential project costs, state and local governments will have an extremely strong incentive to apply for these subsidies, even on projects that are only marginally effective or that will not be ready to be constructed for an extended period of time.
In addition, if the size of the funding program is as large as $3 trillion as indicated, there will be a number of questions relative to the capacity of the construction sector to take on so many projects over a short period of time. As noted above, the size of planned infrastructure subsidies under ARRA was only $100 billion; this proposed program would be roughly 30 times as large, and in our view, it is highly doubtful that such a large “portfolio” of projects could be constructed simultaneously, or close to simultaneously.
The bottom line, in our view, is that the tripartite issues of magnitude and form of subsidies, selection of projects by sector and state, and the timing of construction are issues that will have to be addressed quickly as the planning for such a huge funding program progresses.
Paying the costs of such a proposal
First, the net cost for the Federal deficit could end up being reduced in a number of ways, including an increase in corporate taxes to start. We note that the magnitude of President Trump’s huge tax cut included an aspect which has been insufficiently discussed, in our view: the size of the corporate tax cut from 35% to 21% was substantially bigger than what many tax policy experts anticipated. Initial discussions prior to the enactment of the bill in 2017 put the proposed cut in the corporate tax rate down to the 27%-28% range from 35%. Clearly at that rate, corporate tax revenues would increase significantly from current levels. (We would also anticipate rules to reduce the amount of tax avoidance available to corporations.) In addition, some level of increase in taxes on the wealthy is possible, but may be more difficult. While maximum individual tax rates were not cut sharply under the Trump legislation, there is growing awareness of both income and wealth inequality in the U.S. economy, which could lead to provisions targeting the highest income individuals, and again providing some revenues to pay for the program. Third, given the vast size of costs for the impact of climate change, some increase in efficiency and modernization as we begin to address the costs of climate change could end up being self-financing.
There are a number of the key factors that will affect the climate for infrastructure financing from the fight for an infrastructure reconciliation package through the next several years, as we (hopefully) recover from the COVID pandemic, and move toward sharply more aggressive responses to the threats from climate change.
The ASCE report card: how could it possibly suggest that US infrastructure is in better shape than four years ago?
In its recent report on the condition of U.S. infrastructure, the American Society of Civil Engineers (ASCE) reported as follows: “The highest grade was the ‘B’ in the rail category, while the lowest was the ‘D-’ for the nation’s transit systems. The report finds that 45% of Americans lack reliable access to transit services. Eleven categories received grades in the ‘D’ range. The Report Card covers 17 categories of infrastructure pertinent to all Americans: including a new stormwater chapter, and a spotlight on broadband. With the ongoing COVID-19 pandemic, the need for national broadband infrastructure has become more apparent than ever during the last year. Between 2017 and 2021, five-category grades increased while only one—bridges—decreased. This, combined with state and local governments’ commitment to improving infrastructure, indicating that investment in the United State is trending upward. However, 11 of the 17 categories received scores in the ‘D’ range: aviation, dams, hazardous waste, inland waterways, levees, public parks, roads, schools, stormwater, transit, and wastewater. This demonstrates that much more work is needed to be done to improve the overall infrastructure network.”
Frankly, we are puzzled, over even the modest increase in the aggregate score from D-plus to C-minus, for a number of reasons:
As noted above, state and local governments have not been spending more on infrastructure, nor have they become committed to doing so. There are myriad reasons why the U.S.’s aggregate infrastructure is likely to be in worse shape than it was at the time of the prior ASCE report 4 years ago: a) lack of Federal support, b) tight State and local budgets that were made tighter by the ongoing pandemic, c) pressure on capital budgets from increasing normal costs in most states and cities related to pension/OPEB requirements, and, d) perhaps most importantly, change, which has already generated highly disruptive weather conditions that have both damaged existing infrastructure and created threats of additional damage over upcoming years.
We cite the recent cold weather crisis in Texas, Mississippi, and other parts of the deep south as evidence of the increased costs and increased damage to existing and needed infrastructure, creating vast disruptions to power generation and access to a potable water supply.
In our view, weather-related events are inevitably going to remain highly disruptive and extremely costly to protect against—more about that in the section entitled “Myriad Impacts of Climate Change,” below. With respect to the current status of Infrastructure and the potential outlook, we refer the reader to the excellent piece out of Timothy Little and his team at Standard and Poor’s entitled “Infrastructure After COVID-19: Risk Of Another Lost Decade Of U.S. State Government Capital Investment,” dated October 29, 2020. As the article notes:
- “If state and local government infrastructure investment had continued at the rate prior to the Great Recession, $1.5 trillion more in infrastructure spending would have occurred in 2009-2019.
- In the decade following the Great Recession, state governments devoted significantly less of their budgets to capital spending and reduced their overall debt burden.
- As COVID-19 restricts consumer travel, billions of transportation activity-derived revenues that fund capital projects are at risk.
- The federal stimulus was vital following the Great Recession to prevent steeper declines in capital spending, but there is no agreement on a new comprehensive infrastructure spending plan.”
Strategies for providing and disbursing subsidies are not yet clear.
In any major Federal infrastructure funding program, a key factor will always be the strategies under which projects are selected, and the number of funding subsidies relative to the size of projects is identified. Will state and local governments be required to pledge that they will fund a specified proportion of a given project from their own budget, or through borrowing in the municipal bond market? (Under reconciliation, such a strategy would very likely run afoul of the 10-year “window” for costs of the program.) What proportion of project costs will be required to be paid for by a state or local issuer? Will the state or local component have to be pledged upfront? Will the Federal component be provided through a federal infrastructure bank, or from direct grants-in-aid? How will various capital sectors, such as highways and bridges, mass transit, energy, water, and other infrastructure-related sectors be prioritized?
Using expanded infrastructure spending to offset the severe costs of the pandemic.
Sectoral and regional risks to credits from the pandemic and from climate change remain high, for a number of sectors, including airports, tourism-related activities, universities, extended care facilities, charter schools, and more generally, local governments with weakened economic activity resulting from the virus. We continue to anticipate sectoral and geographic credit pressures, including a number related to structural behavioral changes, such as ongoing increases in work-from-home activities and reduced commercial travel for business-related activities.
Key areas of the U.S. economy
An impending decline in gas tax revenues, as well as in other budgetary revenues in carbon-producing states.
Beyond this discussion, we also note that the sources of Federal support for transportation funding are also permanently at risk: as we move toward a reduced carbon footprint and greater reliance on electric vehicles, revenues provided by gasoline taxes will erode sharply. Gas tax revenues have been a key source of support for spending on highways, roads, and bridges, via the Federal Highway Trust Fund, and via state highway transportation authorities.
We cannot envision how revenues for both of these sources would not come under severe pressure as the move toward reliance on electric vehicles continues to pick up steam. We also note that this transition, as it occurs, will put aggregate state revenues under pressure in carbon-producing states, including Texas, Oklahoma, and Pennsylvania. Again, we are concerned that this type of transition will reduce revenue capacity in these states in the future relative to what it has been before the move toward electric vehicles began.
The need to help fund projects in smaller communities and rural areas. A key topic receiving great attention is the need to help support financing of infrastructure projects for smaller governments, and in rural communities—for transportation, water, and wastewater, broadband, etc. In our view, in all likelihood, at least a portion of the funding provided for this purpose is likely to come through state infrastructure banks. The strategy would be for the Federal government, through its huge package, to provide some funding into infrastructure bank-type programs at the state level, whereby the state could identify and provide funding to smaller communities within its borders.
Rules and regulations at the state level could potentially be promulgated by a given state. Such programs have been successful in some states over a matter of decades—in Ohio, for example, where The Ohio Water Development Authority offers local government agencies (“LGAs”) in Ohio a means of financing the local share of the costs of water and wastewater projects. We expect that this strategy will be replicated for other states in the upcoming program.
Stated state and local priorities: advanced refunding, bank qualified, direct pay.
As we move toward support for state and local government projects, it is important to keep in mind the main priorities of state and local government associations as expressed through the Public Finance Network. These include:
- a) Renewed access to tax-exempt advanced refunding for state and local bond issues. Clearly, access to advanced refunding increases the flexibility of financing for governmental projects and often leads to reduced borrowing costs over time.
- b) An increase in per-issuer access to bank-qualified financing, under which the bank holding the debt can write off the cost of carrying the municipal debt as a deductible expense. Currently, governmental issuers can have up to $10 million in debt outstanding and designate it as BQ. The proposed change would increase the amount to $30 million. Such a shift would seem to be particularly effective in the current environment: according to Fed data, banks increased municipal holdings by $40.9 billion in 2020, after reducing it by $28.1 billion in 2019.
- c) Renewed access to direct-pay taxable municipal debt, which comes with a Federal subsidy equal to a specified percentage of the interest cost of borrowing. Direct-pay debt is the equivalent of the Build America Bonds (BABs) which dominated the long end of the municipal bond market, in particular, while they were permitted in 2009-2010. While this is a potentially complex topic, we note a few things here: first, the percentage of the subsidy during 2009-2010 was 35%; it is not at all clear that, with corporate tax rates down from 35% to 21%, Congress would be considered a subsidy rate as high as 35%. Second, issuers continue to have concerns that the magnitude of the subsidy might be reduced after bond issuance, as they were under sequester rules in from 2010 onward; and third, the case for a BABs-like structure may be stronger than often perceived: during 2009-10, issuer access to BABs also pulled down the cost of tax-exempt financing, as the supply of tax-exempts dropped sharply.
We note that all three of these provisions, if enacted, would provide funding, rather than financing, by potentially reducing debt service costs overtime for the state and local component of the cost of projects.
The increasing role of public-private partnerships, and the links to the Federal program.
As state and local governments endeavor to identify, manage and design key projects, and fund the state/local share, we anticipate that the role of public-private partnerships, aka P3s, will increase quite sharply. A recently initiated very substantial P3 is the $6 billion I 495-270 P3 project being initiated in Maryland. As the project’s manager notes: “The I-495 & I-270 P3 Program is a historic effort to reduce congestion for millions of Maryland drivers by seeking input from the private sector to design, build, finance, operate, and maintain improvements on both I-495 and I-270. Improvements will be focused to transform these overloaded interstates to allow people to reach their destinations faster and to remove overflow traffic from the local roads.” The reason that working with a set of private contractors appears compelling is that, as technological change expands and accelerates, technological expertise will enable the project’s managers to adapt while minimizing costs (e.g., for the insertion of charging stations, use of advanced new materials, project design, and a host of related activities). Our point here is that the Federal Infrastructure program, as it is designed, should also “partner up” with state and local P3 managers, by providing a portion of funding for P3 projects, and by permitting a substantial portion of state/local financing to be issued using tax-exempt debt—and potentially even direct-pay taxable debt. A proper combination of technologically advanced private partners, state and/or local governments funding their share at the lowest possible cost, and the Federal government paying a portion of funding costs could often lead to the lowest possible total costs—especially for major new, complex projects that will need to adapt over time.
The huge and multifaceted impact of climate change on demand for Federal infrastructure financing.
Clearly, climate change is going to lead to increased costs for state and local projects that will require a substantial Federal share. These increased costs will occur in a variety of ways: a) as state and local governments contend with wrenching weather-related events, b) as they design new projects for increased sustainability, c) as demographic shifts occur in response to changing weather conditions, and—importantly on the other side of the “equation”—as governments work to reduce their carbon footprints, and as the private sector moves toward sharply lower carbon outputs. We note that this is a complex, challenging topic that will put pressure on regional, state and local economies in a variety of ways. The challenges related to climate change also relate to a case for greatly enhanced use of P3s, as the economy responds to climate-related pressures through increased use of new technologies.
Social justice issues as a key driver of infrastructure needs—transportation, pollution control, education, governmental services, public health.
The overlaps in spending needs between municipal finance-related issues and social justice-related issues is powerful and expanding, and is clearly a part of where the Administration wishes to go as it works toward enhanced infrastructure. We have little doubt that a variety of infrastructure-related social justice issues are going to receive an important boost under the Biden Administration, including improvements to healthcare and education and reduction in pollution-related damage to minority populations, starting with African Americans. A key concern for the municipal sector is simply this: these transformations are both urgent and costly. In an environment of continuing scarce federal moneys, they may very well create competition for funds with traditional state and local funding requirements. And, all of this will overlap with vast needs for spending related to climate change. How this all tracks over the initial years of the Biden/Harris Administration will be an important consideration for state and local finance that we have never experienced before.
The rapidly growing implications of Technological change—where economic activity is located, and what it looks like.
This includes the transition to electric vehicles from gas-powered vehicles, and a host of other changes in our technological “footprint,” technology-enabled infrastructure platforms, and projects. Clearly, as we have discussed in the past, technological advancements are accelerating transformations in traditional infrastructure, creating opportunities for governments that are positioned to benefit from the deployment of new technologies. In addition, technological change is leading to the “clustering” of technology-based activities in some urban centers, while leaving others behind.
There are rapid changes in the outlook for labor, both positive and negative, as we move toward technological advances and contend with climate change. Employment growth and income growth power sales taxes, income taxes, property taxes, etc. will need to be factored.
The bottom line, for now
An essential component of any major Federal infrastructure program is that it will help enhance the U.S.’s global competitiveness. This, in turn, will help any such program pay for itself in part, by keeping the U.S. economy stronger than would otherwise be the case.
As this list of complex and overlapping issues hopefully makes clear, the apparently imminent administration proposal on infrastructure will have a wide range of components that affect the functioning and funding of state and local governments and projects. And, the costs will inevitably be large. The recently enacted Covid Relief package deals with many of these components, but there is going to be an urgent need to contend with the need for state and local capital projects—infrastructure—and there was precious little in the massive relief package that related to the capital component of these needs of the U.S. economy.
Note: We thank Chris Mier at Rosebud Strategies for his ideas and support in generating this report.