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Funding Questions Remain as Potential Roadblock to $1.5 Trillion Infrastructure Goal

Infrastructure Program Could Face Financing Gap in Wake of Treatment of Traditional Tax-Exempt Bond Financing and Public-Private Partnership Models Under Recent Tax Legislation
February 2, 2018

The New York State Thruway Authority is replacing the Tappan Zee Bridge with a new 3.1-mile twin-span bridge across the Hudson. The $4 billion bridge is one of the largest single design-build contracts for a transportation project in the US. Photo credit: NY State Thruway Authority

President Donald Trump, a commercial real estate developer and now commander-in-chief over what he described in his inaugeral State of the Union address last week as "a nation of builders," provided few hoped-for details in calling on Congress to introduce enabling legislation for a $1.5 trillion program to overhaul the country's crumbling network of roads, bridges, rail systems and airports.

"As we rebuild our industries, it is also time to rebuild our crumbling infrastructure," the president said in calling for a bipartisan effort to produce a bill that will leverage every dollar of federal funding with private sector, state and local spending to "permanently fix the infrastructure deficit."

Many were expecting a more detailed roadmap on funding the ambitious program beyond the president's comments during the speech. For now, all those interested in the program have to go on are the contents of a leaked six-page memo recently published by Axios on the White House's infrastructure investment program, which calls for only about $200 billion -- just a fraction of the total spending goal -- to come from direct federal investment, and largely minimizes the role of the federal government in favor of states and localities coming up with the funding.

Republicans, Democrats and big-city mayors alike have expressed concerns over the reduced federal funding commitment proposed for financing infrastructure improvements, and have questioned how the administration plans to finance the plan without substantially adding to the national debt.

Denver Mayor Michael Hancock said a smaller $200 billion allocation from the federal government for infrastructure projects "is simply not acceptable," noting that during 2016 alone, voters approved $230 billion for infrastructure financing in local elections nationwide.

Building America's Future Educational Fund, a bipartisan coalition founded by two former governors, Edward Rendell of Pennsylvania, Arnold Schwarzenegger of California, and former New York City Mayor Michael Bloomberg, took to Twitter to say, "America’s declining infrastructure is a national problem and deserves to be treated as such. All levels of government have a responsibility to fund infrastructure, not solely states and cities.

"Significant infrastructure reform must include significant federal funding," the coalition said.

Meanwhile, several tax and public finance experts have expressed concerns on the effect that recently enacted tax reform will have on the tax-exempt bond financing and public-private partnership (P3) models apparently favored by the administration for infrastructure financing.

The lion's share of the needed investment under the president's plan presumably would be supplied through the municipal bond debt market by state and local governments leveraged by private companies, including the commercial real estate and financial industries, through public-private partnerships (3P) financed with so-called "private activity bonds" (PABs), which are tax-exempt bonds issued on behalf of municipalities that provide special financing for qualifying projects. Blackstone, BlackRock, Brookfield Asset Management and others began ramping up infrastructure fund-raising last year.

However, PABs are slated to lose their tax-exempt status under the new tax reform law, resulting in higher financing costs since tax cuts and deductions will allow corporations and wealthier individuals to pay vastly less into the tax base used to back the bonds.

Further driving up these costs for municipal bond financing, one of the traditional capital sources for P3 infrastructure projects, will also make funding any ambitious plan more difficult, say tax and finance experts.

"The impact may be large and immediate enough to swamp the short-term impact of any infrastructure package Congress can put together in the immediate future," Aaron Klein, economic studies policy director of the Center on Regulation and Markets at Brookings Institute, argues in recent commentary. By effectively raising the borrowing costs to finance projects, the new tax law runs counter to President Trump's goal of boosting infrastructure investment by outsourcing costs to state and local governments rather than through direct federal investment.

"It will have the opposite impact of the [previous administration's] Build America Bond program... which lowered the cost of municipal debt and helped stimulate greater investment in infrastructure," Klein said.

As with tax reform, commercial real estate has a major interest in any initiative to overhaul infrastructure. The country's vast infrastructure networks, from highways and bridges to freight rail lines, and from dams and ports to water treatment systems, telecommunications and electrical grids, were largely built decades ago. Economists argue that deferred maintenance and rising costs are actually holding back U.S. growth and GDP, even as other countries enjoy more efficient and reliable services because of a public investment in infrastructure that is, on average, nearly double that of the U.S.

A 2014 University of Maryland study found that infrastructure investments added as much as $3 to GDP growth for every dollar spent, with an even bigger impact during a recession, while global consulting firm McKinsey estimates that increasing U.S. infrastructure spending by 1% of GDP would add 1.5 million U.S. jobs. The American Society of Civil Engineers (ASCE) gave the nation’s infrastructure a D on its annual "report card," denoting conditions are “mostly below standard,” showing “significant deterioration,” with a “strong risk of failure.” The group estimates that there is a total infrastructure gap of nearly $1.5 trillion needed by 2025.

Can REITs and PABs Help Fill Project Funding Gap?

Real Estate Roundtable, a real estate industry lobbying group, has proposed creating a capital stack for infrastructure comprised of various funding and financing sources to spread risk, and to hike the federal gas tax used to replenish the Highway Trust Fund, which is reported to be teetering on the edge of insolvency.

Using the real estate investment trust (REIT) structure as a model, publicly listed infrastructure companies are hoping to play an increasing role in fund portfolios, according to Global Listed Infrastructure Organisation (GLIO), established in 2016 to promote the companies to the global investment community.

Opponents of massive federal spending for infrastructure have pushed for new models of private-sector involvement, arguing that it is more efficient and cost-effective. Despite curtailing the former tax advantages for corporations and wealthy individuals previously associated with PABs, the president's proposal calls for expanding the scope and funding of PABs, allowing for the participation by a broader category of public infrastructure, including reconstruction projects, to encourage more private investment.

Given the administration's perspective on a limited federal role in financing major infrastructure projects, a more likely source may well turn out to be state and local governments. Last month, Senators John Cornyn (R-TX) and Mark Warner (D-VA) introduced a bill calling for additional investment in infrastructure projects by allowing state and local governments to enter into P3 partnerships to finance surface transportation projects. The proposed legislation, the Building United States Infrastructure and Leveraging Development (BUILD) Act, would raise the federal statutory cap on PABs issued by, or on behalf of, state and local governments for highway and freight improvement projects from $15 billion to $20.8 billion.

Less than $5 billion in PABs remain under the original statutory cap, and that balance is likely to be consumed in the near future, the lawmakers said in a joint statement. Sen. Cornyn said the bill offers to provide state and local governments with a tool to help finance projects through these partnerships, resulting in "minimal cost to taxpayers, with maximum impact on U.S. highways and freight corridors."

Sen. Warner cited the use of PABs in his state that leveraged private investment in Virginia’s roads and bridges, helping to finance several major projects, including the I-495 HOT lanes and other infrastructure ventures.

To date, the federal government's main tool for funding transportation has been through direct grants to states from the Highway Trust Fund, created in 1956 to fund construction of the interstate highway system. The trust fund raises money through the federal gas tax and other transportation-related taxes, with about 80% of the fund spent on roads and highways and the remainder paying for mass transit projects.

However, analysts have warned that the trust fund faces insolvency largely as a result of no increase in the federal gas tax for many years and the rise of more fuel-efficient vehicles, which is cutting into gas tax revenues. Real estate groups like Roundtable and other business leaders say that, unless the country either raises the gas tax for the first time in more than two decades or sources other funding, the trust fund could run out of money within three years.

The U.S. government also indirectly supports infrastructure funding through financing mechanisms or tax incentives, including the Transportation Infrastructure Finance and Innovation Act (TIFIA), a 1998 law which provides low interest loans and other credits that local governments can use to finance their infrastructure projects. TIFIA has provided nearly $25 billion in financing since its 1998 creation, according to the Congressional Research Service.

Will Tax Reform Work at Odds with Infrastructure Financing?

State and local governments have largely relied on the municipal bond market to finance most local and regional infrastructure projects. Municipalities issue bonds to raise money from private investors, and the U.S. government backs the bonds through a number of tax incentives and exempts the interest on municipal or 'muni' bonds from federal taxes at an estimated cost of about $37 billion a year.

A smaller but growing number of projects are being organized as P3 ventures between government and the private sector. Private firms win a concession from the state to build infrastructure such as highways as well as the right to charge tolls or user fees to cover operations and maintenance costs.

The tax cuts, however, are expected to make it more expensive for state and local governments to borrow through the nation's $3.8 trillion tax-exempt municipal debt market by undercutting the value of municipal bonds, which will have to pay higher interest rates to attract capital, the Brookings Institute's Klein said. Higher interest costs for infrastructure agencies means less money available to build, repair, and upgrade infrastructure.

A second whammy for the muni-market will come from the corporate rate cut, Klein argues. When the marginal tax rate falls, so does the value of being "tax-exempt," he said. With corporate tax rates slashed from 35% to 21%, demand for munis, particularly by banks and insurance companies, will likely fall even more sharply.

Moreover, the tax bill limits the amount of property taxes that can be deducted against federal income tax through what is often called the SALT deduction, a particular burden on states with higher income taxes which have some of the oldest and most decaying infrastructure.

"Limiting the SALT deduction will increase the cost of property taxes to voters, who ultimately have control over whether state and local governments go forward with new infrastructure projects," Klein said.

David B. Hamilton, tax and wealth-management attorney with Womble Bond Dickinson, speculated that the White House may have made a strategic decision to hold back on introducing infrastructure legislation until tax reform cleared Congress.

"The issue is apparent," Hamilton said. "A fully funded infrastructure bill, the funding mechanism desired by the Democrats, is likely not achievable."

With President Trump wanting $200 billion allocation from the government and the remainder from the private sector, the administration will be looking to corporations to plow some of the anticipated tax earnings back into infrastructure projects.

"What incentives will be offered will be worth watching," Hamilton said.

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