A progressive view: There are no shortcuts to building 21st century infrastructure
By KEVIN DEGOOD
Infrastructure projects cost money. No amount of hand waving or fancy financial jargon can overcome this fact. Unfortunately, this hasn’t stopped the Trump administration from trying.
Throughout his presidential campaign, Donald Trump repeatedly vowed to spend $1 trillion to rebuild America’s crumbling infrastructure. As president, however, this pledge has been replaced with calls for state and local governments to “maximize leverage” by taking on expensive private equity capital through public-private partnerships, or P3s. The federal contribution to these deals would be limited to a tax credit for equity investors.
To understand the deep flaws with this approach, it helps to know how governments pay for infrastructure.
For smaller maintenance and expansion projects — such as repaving a stretch of state highway — state and local governments use a pay-as-you-go method, meaning they cover the full cost of construction with tax revenues already in place.
For larger projects — such as building a new light rail line — governments finance a portion of the overall cost by issuing tax-exempt municipal bonds. Congress allows investors to earn interest income tax free to lower public sector borrowing costs under the theory that the resulting infrastructure delivers broad public benefits. The current interest rate on a municipal bond with a 30-year maturity and a AAA rating is only 3 percent.
The municipal bond market is active and robust, with more than $3.8 trillion in outstanding issuances. Furthermore, investors have a strong appetite for new issuances. These characteristics of the municipal bond market reveal an important point: State and local project sponsors do not lack access to financing. Instead, the principal constraint facing state and local governments is insufficient tax revenues to repay new project debts.
President Trump and Secretary of Transportation Elaine Chao have both talked about the need to get private equity capital “off the sidelines” and into more U.S. infrastructure projects. Underpinning these statements is the notion that project sponsors face capital scarcity. This is fundamentally wrong. Project sponsors have access to low-cost capital through the municipal bond market.
The rhetoric around private capital and P3s has understandable appeal. After all, private participation sounds like a burden is being lifted from the government and — by extension — taxpayers. The truth is far less appealing as equity capital comes at a steep price.
Depending on the project, equity investors may look for annual returns of 15 percent or more. This raises borrowing costs substantially. The finance charge on $100 million of municipal debt at 3 percent over 30 years is $90 million. By comparison, $100 million in private equity capital at 15 percent over 30 years has a finance charge of $450 million. Even when factoring in the Trump administration’s proposal to provide investors with tax credits, equity capital is still vastly more expensive than municipal debt.
Additionally, equity capital and public-private partnerships don’t work for rural areas, small towns and cities facing economic hardship because these communities would not generate the revenues needed to satisfy equity investors’ profit demands. The value of P3s is not financing. Instead, the real benefit is that P3s allow state and local governments to offload project construction risk to a private firm through a fixed-price contract. Importantly, the potential gains from this form of contracting apply only to the largest and most complex mega projects. However, mega projects account for a small fraction of the infrastructure needs facing the nation.
Instead of pushing deals with overpriced equity capital, Congress should pass a major infrastructure bill that provides direct funding to state and local government project sponsors. With real federal money on the table, many state and local elected officials would be willing to take the politically challenging step of raising more tax revenue to match federal dollars. This virtuous cycle would yield a substantial increase in overall construction activity to repair and expand our infrastructure assets. This would improve the ability of companies to efficiently produce goods and services while also helping families to safely and affordably access jobs, health care and education, among other daily needs.
Kevin DeGood is the director of Infrastructure Policy at the Center for American Progress.