$2 Trillion Infrastructure Gap and Tax-Exempt Bonds

$2 Trillion Infrastructure Gap

On March 9, 2017, the American Society of Civil Engineers gave U.S. infrastructure a cumulative grade of D+, finding that “we can no longer afford to defer investment in our nation’s infrastructure. To close the $2.0 trillion 10-year investment gap, meet future needs, and restore our global competitive advantage, we must increase investment from all levels of government and the private sector from 2.5% to 3.5% of U.S. GDP by 2025.”  (emphasis added)

The engineers gave schools, roads, water systems, and airports grades of D or D+ which means they are in poor condition and at “strong risk of failure.”  A recent Government Accountability Office report found that nearly 25 percent of all bridges in the nation are deficient.  

According to the McKinsey Global Institute (MGI), the U.S. lags far behind other countries in infrastructure investment.  From 2008 to 2013, China invested 8.8% of GDP annually; India 5.2%; Russia 4.5%; Japan 4.0%; Canada 3.5%; compared to 2.4% of GDP invested by the U.S.  See FedWeb’s Infrastructure webpage

Infrastructure Investment Would Raise GDP and Create Jobs

Increased investment in U.S. infrastructure is necessary to ensure the health, safety, and competitiveness of our citizens. In addition, there is broad agreement that closing the infrastructure gap would grow the economy and create jobs. The McKinsey study projects that ramping up investment in infrastructure over the next decade could boost U.S. annual GDP growth by as much as 1.3 percent – creating more than 1.5 million new jobs.   

Three Major Obstacles to Closing the Infrastructure Gap

There are three major obstacles to closing America’s $2 trillion infrastructure gap.

First obstacle – aiming too low: The Trump Administration has called for an investment of $1 trillion over 10 years – half of what the engineers estimate is required to close the infrastructure gap. A strong and compelling case can be made for a more robust, long-term commitment to close the entire $2 trillion gap — given the substantial health and safety risks from an aging and obsolete infrastructure; today’s rare opportunity to finance long-term investments at low-interest rates; and the importance of smart infrastructure to U.S. global competitiveness.

Second obstacle – opposition to the federal role in funding infrastructure:  Some in Congress and the Administration are ideologically opposed to a substantial federal role in financing U.S. infrastructure, asserting that U.S. infrastructure is fundamentally a State, local, and private sector function. Reflecting this bias, the President’s FY 2018 Budget proposes to limit the federal contribution to $200 billion over 10 years, with only $5 billion requested FY 2018.  

Contrast this opposition to a federal role in infrastructure, with the views that prevailed in the 1950s, when President Eisenhower signed multiple Federal-Aid Highway Acts establishing a 60-40 federal-state partnership that created an unparalleled, transcontinental national highway system. At the time, one of the political justifications was national defense, but construction of the national highway system helped to fuel an economic boom.

Third obstacle – opposition to increased domestic spending:  Fiscal conservatives in Congress and the Administration strongly oppose any increases in domestic discretionary spending. The Administration, in the recently-released FY 2018 Budget, proposed the largest-ever cuts to non-defense discretionary spending—more than 10 percent in FY 2018 alone, including a 17% cut in the Department of Transportation, and 29% in the Army Corps of Engineers.  See FedWeb’s FY 2018 Budget page

Given these political realities and the de-emphasis of the federal role, the Administration and congressional leaders may, in the near-term, supplement limited federal funding with tax-exempt State and local governmental and private-activity bonds.

State and Local Tax-Exempt Bonds

The federal government subsidizes the cost of most State and local governmental bonds by excluding interest income from federal taxation, i.e., the bond buyer does not include the interest in federal gross taxable income.  This typically enables State and local governments to raise capital from investors at reduced interest rates (known as the “spread.”)  As long as the State and local bonds are used for a “public purpose” – which can include roads, bridges, and other types of vital infrastructure — State and local governments can use tax-exempt financing to significantly boost infrastructure investment.

Tax Credit bonds (TCBs)

Another form of tax incentive for State and local financing is the tax-credit bondUnlike the tax-exempt bond, which excludes interest earnings from taxable income, the TCB offers an issuer or investor a federal tax credit that is a set percentage of the interest cost. 

TCBs have been used to boost a wide variety of public interests, some of which involve infrastructure: public school construction; energy projects; recovery from natural disasters; and targeted economic development projects.  The President’s FY 2017 Budget proposed creation of a new TCB for certain infrastructure projects.

Qualified Private Activity Bonds

Some types of infrastructure projects may provide both public and private benefits. Even though such projects are not entirely governmental, they may nevertheless qualify for tax-exempt financing as “qualified private activities.”  At present, there are 22 types of “qualified private activities” including facilities that are infrastructure-related: airports; docks; commuting hubs; rail; water; sewer; solid waste disposal; energy; and education.

Tax-exempt financing for some of the 22 types of qualified private activities are limited by annual “volume caps” calculated on a state-by-state basis, the purpose of which is to limit federal revenue losses. One way to boost infrastructure investments would be to raise the State volume caps on qualified private activity bonds used for specified classes of infrastructure.

Federal Revenue Cost

Tax-exempt, tax-credit, and private activity bonds have a federal budget cost. Federal revenues decline by the amount of taxes that would have been paid on the interest income in the absence of the tax exclusion, or in the case of TCBs, the taxes that would have been paid in the absence of the tax credits.   

The Statutory Pay-As-You-Go Act of 2010 (“PAYGO”) requires Congress to fully offset any new or expanded cuts. However, recent experience suggests that Congress is likely to ignore the PAYGO requirement for tax cuts.  For example, Congress passed major tax cuts in 2015 (the “PATH” Act) to extend or make permanent numerous tax deductions and credits. The nonpartisan Joint Committee on Taxation estimated the PATH Act would lose $622 billion in federal revenues over 10 years, but Congress waived the PAYGO requirement by excluding the tax cuts from annual PAYGO calculations.  See further details on our Budget Process webpage.