Reprint: The Search for a Better Public Infrastructure Financing Model

I served on the USEPA’s Environmental Finance Advisory Board (EFAB) for 7 years. I met many smart people in the field of infrastructure finance. Most were pushing for innovative and equitable strategies to fund public infrastructure. We need one nationally and at the state level! The article below from Bond Buyer suggests some good ideas. Federal-state-local collaboration is essential to successful infrastructure financing. The starting point is capital improvement budgets that reflect the top local area project priorities! That can be achieved through a Build Up Greater Cleveland approach and in other ways. What does not work is just sitting around a table and picking projects based on personal preferences, political pressure, and past reasoning. The key is analysis that demonstrates how and why projects should be top priorities. Then, a strategy must be built to acquire the funds needed from all sources. Rural areas must be especially smart and aggressive in funding infrastructure projects. So read the article below and think about it.

Washington policy makers are lumbering toward a funding solution to address the massive backlog of U.S. infrastructure needs — a discussion likely to continue well into the next Presidential administration. Underlying this funding issue is an equally important  debate focused on advancing a financing model — not to be confused with securing more  funding — the proper resolution of which is critical to the prudent expenditure of whatever amount of additional revenue is forthcoming.

For over a decade, two financing models of addressing the poor condition of U.S. infrastructure have sparred with each other. The long-standing municipal bond market has generally prevailed, aided by its access to low cost, attractive funding levels as its interest payments have tax-free status under federal and state law. The other, and more recent model, is the public-private partnership (P3) model, an officially sanctioned approach of many other Western developed countries, including Canada, Australia and much of Europe.

One key difference between these developed countries and the U.S. is the latter’s municipal market with its special status under the federal tax code giving state and local government lower cost borrowing than even the U.S. Treasury itself. As such, it is less available to P3 projects due to federal tax code restrictions on the private use of municipal bond proceeds.

The importance of this financing cost differential is evident, for example, in the public sale of a 50 year right to operate and receive the benefit of the water system of Allentown, Pa. To execute on this plan, in 2013 the City held an auction to award the contract to the highest bidder. Despite private investors and operators active in the P3 market responding to the auction, the winning bid went to a County authority in which Allentown is located. Its high bid was financed with the proceeds of lower cost, tax exempt debt thus enabling it to pay more than any other bidders.

For several years, bipartisan policy makers, including representatives from within the Obama administration along with economic think tanks and academics have advocated for the adoption of the P3 financing model by state and local government for their respective infrastructure programs. Despite this advocacy, the P3 market has been slow to develop in the face of the significant municipal versus private financing cost differential.

This is despite certain advantageous aspects of the P3 financing model.  To cite just two examples: the design-build procurement approach, which offers efficiencies on project cost, and life-cycle budgeting that in many cases better plans for maintenance of essential infrastructure over the time period of its expected use.

Beyond the funding differential between P3 and the municipal market, there are other more structural reasons why P3 has not yet been widely adopted.  For example, P3’s procurement approach — design/build and operate/maintain — runs counter to many existing public bidding procedures embedded in the legal structures of state and local government.

Additionally, many public officials mistake P3 as a funding source which it surely is not — private operators expect to be repaid for their services and financing. Therefore, just like traditionally procured infrastructure, some form of governmental revenue source and/or user fees are essential to the success of P3 procurements.

And, in a few states and cities, some in organized labor have expressed opposition because of concern that P3 is a vehicle to displace workers — although in reality, this is typically not the case. Finally, it is inherently different from the historic infrastructure model of bidding-out a construction contract, financing it with municipal tax-exempt debt and overseeing the project by way of a governmental agency.

Change of this magnitude takes time and a great deal of public education.  Understanding the benefits of P3 requires in-depth knowledge of both the financial markets and the world of infrastructure design, engineering and construction.

To that end, in the fall of 2014, the U.S. Department of Treasury convened a conference to sort through how best to advance an infrastructure agenda. Part of that discussion led to ideas on how a combination of the two financing models might work best to accomplish an important policy objective of more and better infrastructure. Put another way, if tax exempt financing is the lowest cost financing option for state and local government, how might it be combined with the P3 model to achieve the benefits of both approaches?

This, in part, led to the Obama administration’s proposal to create a new class of tax-exempt debt that is permitted within the context and requirements of P3 projects. The proposal, which has been well-received by a variety of infrastructure industry experts, is an important recognition of the financing cost challenge faced by P3 sponsors and a hopeful sign of a way forward in creating a new hybrid infrastructure financing model. According to former Governor Haley Barbour of Mississippi, and as reported in The Bond Buyer, this new category of tax-exempt debt “could be the icebreaker that gives states the ability to do their first P3 project and see the advantages.”

Senators Ron Wyden, D-Ore., and John Hoeven, R-N.D., have introduced their own version of the Obama Administration’s proposal intended to accomplish the same goal: broaden availability of tax exempt financing for private involvement in public infrastructure projects.

The approach of New York Governor Andrew Cuomo’s administration to the financing and construction of the new Tappan Zee Bridge is another example of using a hybrid financing model to develop a large-scale infrastructure project within the context of current law.

Simply stated, Governor Cuomo’s Administration has used the design-build procurement aspect of the P3 model to select a private engineer and contractor to lower the overall cost of constructing the bridge. However, the financing of the project remains in the traditional municipal market, achieving the lowest cost financing option.

These examples reflect a more nuanced understanding of the advantages of the respective infrastructure models, suggesting a convergence of the two rather than a competition as the optimum course. The infrastructure industry alongside its partners in government should increasingly focus on how to do more with existing revenues and this hybrid approach may best address a national goal long in search of a pathway forward.

While it may take longer than the next two years to bring this concept together to scale, it is the type of bipartisan, common sense solution both parties in Congress, the White House, and state and local officials can embrace. Participants in the infrastructure industry — P3 and municipal alike — should apply their best thinking to advance an integration of their two worlds for our country’s critical infrastructure needs.

Chris Hamel is head of U.S. Municipal Finance at RBC Capital Markets

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