March 2017

US Infrastructure: Funding is the Problem, not a Shortage of Capital

This piece, originally featured in The Bond Buyer, was written by Chris Hamel, Head of US Municipal Finance at RBC Capital Markets.

President Trump and Congress deserve a pat on the back for appearing to have an active interest in addressing the critical condition of U.S. infrastructure underfunding. But to truly advance the discussion, they must focus on the real challenge, which is not different sources of capital, but the need for more funding.

The key difference between funding and capital is simple, yet often misunderstood. Capital is borrowed money used to finance a given project and funding is the means by which to pay it back, regardless of the source of that capital.

The U.S. infrastructure challenge does not suffer from a shortage of capital. There are multiple ways for state and local government to borrow money to finance infrastructure: through the traditional municipal bond market that finances about 75% of annual infrastructure spending, assorted federal programs and increasingly the private sector which has an active interest in expanding its investment in American infrastructure.

The critical problem is finding added revenue sources to pay back that capital.

One useful federal policy revision would be to make it easier for different forms of capital, such as private equity investment, to work side-by-side with municipal debt. A generation of federal law and regulation has, by design, limited government's ability to use low cost, tax exempt financing in conjunction with private sector involvement. In turn, this has also limited the ability to use alternative forms of capital that may have other advantages than simply the cost. This reform would help government more easily utilize the private sector to adopt an innovative, hybrid approach to infrastructure financing and begin to address more of the nation's infrastructure challenges.

President Trump's Administration has stated it intends to advance public-private partnerships (P3) as one solution to infrastructure underfunding. In a press briefing on February 23, White House Press Secretary Sean Spicer, after a recent Presidential meeting with U.S. business leaders, stated that, "CEOs and administration officials agreed that public-private partnerships will be the cornerstone of a robust plan to rebuild the nation's crumbling infrastructure."

This infrastructure model brings with it certain private sector advantages such as design-build procurement that has been shown to save time and lower the cost of infrastructure so that government can do more with existing resources. It also provides a private sector discipline to long-term maintenance for which government is generally less adept.

But all forms of capital still need to be paid back, which is why any meaningful solution must address this critical yet politically challenging issue.

A Trump campaign policy paper last year suggested that tax credits may be one form of infrastructure subsidy. Not to be confused with tax credit bonds which were previously proposed by some public officials and for which there is little investor appetite, tax credits have been an effective tool through the years to promote investment in low income housing development and renewable electricity generation.

The Trump campaign paper was more an expression of a concept than a specific proposal. A key challenge for tax credits in the infrastructure context would be to determine how to make them work with public infrastructure that doesn't always have a direct source of revenue to fund it. Conceding that point, if it is the judgement of Washington to provide subsidy to infrastructure development, then the proposal should be thoughtfully reviewed.

This leads to one other important observation: the U.S. needs a 21st Century approach to funding its infrastructure that combines the low cost effectiveness of the municipal tax-exempt market with the efficiencies of the private sector, as represented by certain aspects of the P3 model as previously described. This means that the prospect of corporate tax reform should not place limits on tax exemption, because to do so would increase the cost to state and local government (meaning taxpayers) and would, in fact, only detract from a solution to the infrastructure underfunding problem.

Washington should focus on expanding infrastructure finance options that combined are an expression of a uniquely American approach to P3. By adopting aspects of a model that have worked in other Western economies and sculpting it around the many effective qualities of U.S. municipal finance and our decentralized approach to U.S. governance, we can provide state and local government with more flexibility and promote greater innovation to help address our nation's critical infrastructure needs.

Unless we accommodate the core characteristics of American governance and its financing of infrastructure, then the P3 model will continue its largely ineffective advancement in the U.S. of the last decade or two.

An updated infrastructure finance model combined with expanded funding sources will go a long way toward achieving the level of infrastructure investment our country sorely needs.