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ederal Desperate Times Call for Innovation · governments, sequestration is materi-alizing into reduced state aid, which ... would be a new kind of PAB that would have no expiration

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Page 1: ederal Desperate Times Call for Innovation · governments, sequestration is materi-alizing into reduced state aid, which ... would be a new kind of PAB that would have no expiration

54 Government Finance Review | August 2015

Governments are

searching for short- and

long-term solutions that

may make significant

changes to the funding

landscape to support

public infrastructure

development.

Post-recession, state and local governments have had to make difficult decisions about how

to fund traditional services while addressing population growth and new demands. Though state and regional economies have mostly stabilized from the worst of the Great Recession, expen-diture demand is still rising much faster than revenues. For all levels of govern-ment, the ongoing challenge of slow economic growth, political polarization, tight budget constraints, debt limits, and austerity policies have meant delays in delivery of much-needed public infrastructure projects — despite the large voter appetite for improvements to roads, bridges, public transportation, and water and power delivery systems. In the face of these challenges, gov-ernments are searching for short- and long-term solutions that may make sig-nificant changes to the funding land-scape to support public infrastructure development.

PARTISAN GRIDLOCk IS ThE MOThER OF ALL INVENTION

Emerging at a time of particular-ly strained partisan relationships in Washington, D.C., the 2011 decision to ban congressionally directed spend-ing, or “earmarks,” removed the chief bargaining tool used by members of Congress to broker deals for more than 200 years. Though a deep ideo-logical divide on many critical issues remains the most prominent culprit for

Washington’s decreased productivity in recent years, the ban marked an end to millions of dollars in annual federal funding for many state and local infra-structure projects, and the beginning of a new era of fiscal focus in the nation’s capital. The ban was followed later that year by the Budget Control Act, legislation that began imposing across-the-board spending cuts on federal domestic and defense discretionary funds. The sequestration, which began in 2013, is projected to reduce fed-eral spending by $1.2 trillion by cutting $109 billion per year, divided mostly between defense and non-defense dis-cretionary expenditures.

The 2011 deficit reduction exer-cise could not have come at a worse time for state and local governments, which were still working feverishly to revive their economies after the Great Recession. According to the Economic Policy Institute, roughly 18 percent of federal aid to states is subject to sequestration, which translates into 5 percent of total revenues. For local governments, sequestration is materi-alizing into reduced state aid, which represents almost 30 percent of local budgets. The first year of sequestra-tion cuts trimmed roughly 5 percent from total federal outlays to states, with corresponding cuts scheduled annu-ally through 2023. Victims include State and Local Law Enforcement Assistance, Workforce Training, and Elementary and Secondary Education programs,

Desperate Times Call for InnovationBy Dustin McDonald

Federal Focus

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Agust 2015 | Government Finance Review 55

and the federal subsidy for the Build America Bonds program, which has seen reductions ranging from 8.7 per-cent to 7.3 percent since 2013.

Sequestration has had rolling impacts across state and local gov-ernments, forcing reductions in some service areas as well as reprogramming of scarce resources to meet needs in other budget categories. While health, education, and public safety commit-ments have struggled, federal, state and local policy makers have increasingly focused on addressing inadequate investment in public infrastructure to help spur economic growth. Much of this discussion is centered on the need to reauthorize federal surface transpor-tation legislation, which has eluded a long-term legislative solution since the 2009 expiration of SAFETEA-LU. Falling victim to hyper-partisan disagreement over federal spending, a successor to the multi-year highway, road, bridge, and public transit law was not enacted for nearly three years, during which Congress provided the federal commit-ment to federal transportation programs through 10 short-term extensions. In the end, three years of painstaking nego-tiations only produced MAP-21, a two-year $118 billion bill maintaining fund-ing for federal transportation programs at existing levels. This is a significant departure from previous transportation reauthorizations such as SAFETEA-LU, TEA-21, and ISTEA, laws that extended funding to federal transportation pro-grams for periods of four to six years that weighed in at $286 billion, $217 billion and $155 billion, respectively.

The idea behind longer funding cycles has been to give state and local governments assurance in the consis-tent distribution of federal dollars used

to fund years-long transportation proj-ects. But the enthusiasm for obligating such large sums for these extended lengths has waned as gas tax returns into the federal Highway Trust Fund have diminished. Increased vehicle fuel efficiency as well as a recession-induced drop-off in driving has lowered gas-tax revenues to the highway fund, leading to tough debates in Congress and among transportation advocates over how best to keep the needed rev-enues flowing into the fund.

While some say the fuel tax should be raised — it has not been increased since 1994 — others are making the case for usage-based alternatives such as a vehicle miles tax and greater toll-ing authority. Some are even promoting the notion of either freezing or reduc-ing the federal gas tax and shifting the responsibility of infrastructure spend-ing onto the states. As the debate rages on lawmakers have rallied consensus to borrow money from the general fund to backfill the increasing gulf in the Highway Trust Fund. Since 2008, lawmakers have made $53.6 billion in transfers and there have been 32 short-term extensions of the highway fund-ing law during the last six years. These emergency cash infusions, which are estimated to increase transportation project costs by close to 30 percent, will continue unless Congress agrees on a long-term funding formula for the Trust Fund. As of publication, Congress was again preparing to consider anoth-er short-term extension that would fund federal surface transportation programs through December.

In this atmosphere, a group of federal elected leaders and department and agency bureaucrats are diligently work-ing to craft lower-cost alternative trans-

portation investment programs that might appeal to members of Congress who fail to draw the connection between functioning infrastructure and economic growth. Several members of the House Ways and Means Committee and the Senate Finance Committee, along with the White House, are work-ing to build support for taxing the for-eign profits of U.S. companies and fun-neling those new revenues, which are estimated to generate as much as $268 billion, into the Highway Trust Fund.

Meanwhile, Senators Ron Wyden (D-OR) and John Hoeven (R-ND) intro-duced the Move America Act, legisla-tion that would create a new bond and a new tax credit program designed to encourage private investment in pub-lic infrastructure. The bond proposal would function as a modified version of Private Activity Bonds (PABs). While Move America Bonds would be subject to an annual state volume cap, they would differ from PABs by exempting interest income on the bonds from the Alternative Minimum Tax (AMT). The bonds would also differ from PABs by permitting private ownership and operation of facilities financed by the bonds so long as those facilities are for public use. Qualified projects to be financed by the bonds would include airports, docks, wharves, mass com-muting facilities, railroads, highways, and flood diversion and inland water-way improvements.

The legislation also introduces Move America Credits, which would function much like the Low-Income Housing Tax Credit (LIHTC) and could be used to finance projects also funded by Move America Bonds. The credits would be allocated to states, which could then sell the credits to raise

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56 Government Finance Review | August 2015

capital or allocate them to sponsors of projects. Project sponsors could claim the credits or sell them to raise capital. Unlike LIHTC, the credits could be used to construct facilities that are privately owned.

Further down Pennsylvania Avenue, the White House proposed qualified public infrastructure bonds (QPIBs) in its 2015 annual budget request. QPIBs would be a new kind of PAB that would have no expiration date or issuance caps, would not be subject to the pri-vate business use test currently used to determine if bonds are governmental bonds or PABs, and would also exempt interest income earned on the bonds from the AMT. QPIBs could only be used to finance governmentally-owned projects, and could not be used to finance or privatize public systems or finance privately owned facilities. The Treasury Department is also exploring options to modify federal tax rules on PABs. Specifically, the department is looking into changes to PAB alloca-tion and accounting rules in an effort to identify improvements that can be made where projects have part govern-mental use and part private business use that could promote greater applica-tion of P3s.

Washington’s focus on PABs and P3s is rooted in recognition of the continu-ally decreasing revenue inflows to the Highway Trust Fund and a lack of politi-cal will to increase the federal gas tax to bring in additional revenue. Federal policy makers are also aware that the current interest rate environment, an increase in the use of bank loans and the fact that many governments have reached their debt issuance limit is resulting in a decrease in new tax-exempt bond issuances. Appreciation

for these circumstances is leading Congress and the White House back to the drawing board to figure out how to engage the private sector in public projects.

NO GUTS, NO STRUCTURALLy DEFICIENT INFRASTRUCTURE REPLACEMENT SOLUTIONS

Miles from the dysfunction in Washington, D.C., state and local governments, conscious of the same financing constraints, are leading the way to fund their capital improvement priorities outside of the traditional tax exempt bond market. In February 2015, the Commonwealth of Pennsylvania raised $800 million through PABs to support the Rapid Bridge Replacement Project, a P3 that will replace 558 structurally deficient bridges in three years. Pennsylvania’s first foray into the world of P3s was made possible by 2012 and 2013 state legislation that empow-ered it to explore P3s and restruc-tured the state’s gas tax and increased several fees to arm the common-wealth with new resources to address its heavy infrastructure mainte-nance backlog. With a 2014 Federal Highway Administration report estimat-ing the total number of structurally deficient bridges across the country at 61,000, the Rapid Bridge Replacement Project could become a national model for states. Pennsylvania’s Public-Private Transportation Partnership Office is now working to apply a P3 model to fund, build, and operate more than 30 public transit natural gas fueling stations.

P3s present a number of challenges and opportunities for governments. To provide guidance to the many

governments exploring P3s as a tool to jumpstart infrastructure projects, and even provide some government services, GFOA’s Executive Board approved an advisory in January 2015 to alert finance officers to some of the risks related to these financing arrangements. The document, Public Private Partnerships (P3s), is available on the GFOA website at gfoa.org. It explains that P3 agreements can leave a public entity exposed to fiscal and/or political fallout if proper due diligence does not occur, the private partner fails to perform, or if expected project outcomes do not happen. The advisory goes on to recommend that governments involve their finance officers in all P3 discussions, and that failure to fully understand the overall financial implications, including what the public entity may forfeit, can result in P3 agreements that may not serve the public interest or that may even be detrimental to the long-term financial health of the organization.

Other governments are finding success in funding their transporta-tion obligations through more tradi-tional, yet politically grueling, means. In eight states this year, governors and state legislatures have sum-moned the courage to increase gas taxes that federal lawmakers have not been able to conjure up since 1994. Georgia, Idaho, Kentucky, Nebraska, North Carolina, South Dakota, and Utah voted to increase their state gas taxes in 2015 to address their public infrastructure needs. Four other states — Massachusetts, New Hampshire, Vermont, and Wyoming — increased their gas taxes in 2013 and 2014, while Maryland, Pennsylvania, and Rhode Island voted to index their gas taxes for

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Agust 2015 | Government Finance Review 57

inflation or fuel prices during this same period. Some states that successfully updated their gas tax laws also sought to find unconventional revenue sources as well as account for advancements in transportation technology that has put more than 11 million alternative fuel vehicles on the road, according to 2011 estimates by the U.S. Energy Information Administration. For exam-ple, Georgia’s new law places a $200 annual fee on electric vehicles, a $5 per night fee on hotel stays, and a weight-based fee on trucks ranging from $50 to $100. These proceeds, which the state estimates will produce $1 billion per year, will all be funneled to the state’s transportation needs.

A key component of success for those states that won approval of gas tax increases was a focus on the length of time since gas taxes were last raised. Many state elected officials can now appeal to colleagues and voters using this same logic. A 2015 Institute of Taxation and Economic Policy sur-vey revealed that 20 states have not increased their gas tax rates in over 10 years; 15 states have not done so in 20 years; and five states have not increased their gas taxes in even lon-ger. Tying low gas tax returns, the need to modernize out-of-date tax laws and the responsibility of governments to provide infrastructure capable of sup-porting long-term economic growth can be a very persuasive message. State and local governments are proving this. Let’s start asking our federal elected leaders to do the same. y

DUSTIN MCDONALD is the direc-tor of GFOA’s Federal Liaison Center in Washington, D.C.