Fixing America’s Infrastructure: At What Cost?

Look around America. You’ll see the most impressive infrastructure of any nation on earth. Grand bridges, vast networks of power lines, giant dams, miles-long levees, communication towers, endless streets, unending interstates, and incredible plumbing under the ground. And think what these networks do:

• For pennies we can call anyone, anywhere, in this huge country.
  
  
• We enjoy a road network that connects every area of the country to major traffic arteries.
  
  
• The vast majority of our homes have telephones, televisions, plumbing, and easily traversed streets connecting them.

Sound infrastructure—roads, bridges, power grids, drinking water, wastewater, dams, transit, rail and aviation facilities—forms the backbone that is critical to maintaining and enhancing economic growth, competitiveness, productivity, and quality of life. For many decades, it was America’s infrastructure that gave her the competitive edge.

But the world has changed…or rather, aged. America’s infrastructure is growing increasingly obsolete, putting America at a disadvantage in the evermore competitive global economy.

Our once-beneficial infrastructure is now the source of recurring catastrophes. The chart that follows details just a few of these noteworthy infrastructure failures.

“A modern economy needs a modern platform, and that’s the infrastructure,” investment banker Felix Rohatyn, co-chair of the Commission on Public Infrastructure at the Center for Strategic and International Studies, said in a recent New York Times interview. “It has been shown that the productivity of an economy is related to the quality of its infrastructure.”

In its 2005 Report Card on America’s Infrastructure, the American Society of Civil Engineers (ASCE) gave updated grades to the country’s infrastructure since it first assigned it a collective D+ in 2001. The ACSE’s overall grade of D signifies little to no improvement. The bottom line: U.S. infrastructure is in sad shape, requiring more than a trillion and a half dollars over a five-year period to bring it back to a reasonably adequate condition.

Roads and Water

The ASCE estimates that poor road conditions cost U.S. motorists $54 billion per year in repairs and operating costs—$275 per motorist. Total annual spending of $59.4 billion is well below the $94 billion needed annually to improve transportation infrastructure conditions nationally.

The American Association of State Highway and Transportation Officials (AASHTO) estimates that capital outlay by all levels of government would have to increase by 42 percent to reach the cost-to maintain level, and by 94 percent to reach the $125.6 billion cost-to-improve level. In contrast, the Federal Highway Administration estimates that outlay by all levels of government would have to increase by 17.5 percent to reach its projected $75.9 billion cost-to-maintain level, and 65.3 percent to reach its $106.9 billion cost-to-improve level.

When it comes to water, America faces a shortfall of $11 billion annually to replace aging facilities and comply with safe drinking water regulations. Unless the nation invests nearly $1 trillion over the next two decades in drinking water and wastewater upgrades alone, we face the risk of reversing the public health, environmental, and economic gains of the past three decades.

Click graphic above to view a larger version.

 

Click graphic above to view a larger version.

Who Pays?

The reality is we all pay for infrastructure in one way or another—through income and property taxes, fuel taxes at the gas pump, tolls or transit fares, surcharges on our electric bills, monthly water consumption fees. But the big dollars needed to repair our crumbling systems are beyond the budgets of local and state governments. More sobering, the bill has become too large for the federal government.

Take transportation, for example.

Our interstate roadway system was planned more than 75 years ago, and the mechanism devised for its dependable funding, the Highway Trust Fund, was created by the Highway Revenue act 51 years ago.

About 45 percent of all highway spending comes from the trust fund, which gets its money mainly from the 18.4 cents-a-gallon excise tax that drivers pay at the pump. Of this, about 15.44 cents goes to the highway trust fund, 2.86 cents to mass transit programs, and one-tenth of a cent to a leaking underground storage tank fund.

Gasoline was only 30 cents a gallon and the excise tax on it was just three cents in 1956 when Congress created the fund. Now, decades later, interstates are reaching the end of their typical 50-year life cycles and require expensive rebuilding or revamping. As gasoline prices rose during the interim, so did the tax. But a tax-adverse Congress has kept it at 18.4 cents per gallon since 1993, when gasoline prices were about $1.10 a gallon. Today, the gas tax is less than one-half of 1960 levels, adjusted for inflation.

At the end of 2000, the Highway Trust Fund had a balance of almost $23 billion. By the end of 2006, that balance had fallen to $9 billion. Between inflation and improved fuel efficiency, federal tax dollars are disappearing. The Congressional Budget Office predicts the fund will run a deficit of $1.7 billion at the end of 2009 and $8.1 billion by the end of 2010, when the current highway program expires.

In its report on global infrastructure, the Urban Land Institute states that this scenario extends to other forms of aging infrastructure, especially in cities built early in the last century or before. Deferred maintenance leads to greater capital costs with the burden placed increasingly on local governments. The federal government just won’t pitch in anymore—“no new taxes.”

So, the real question emerges: how will we pay?

Alternative Funding Mechanisms

Traditionally, government agencies raise capital for new construction through public bonding. This approach spreads the debt over the useful life of the asset and delivers infrastructure when it’s needed. The beneficiaries of the capital investment pay the up-front bill. Potentially high borrowing rates, limited future budget flexibility, and pushing the debt service onto future generations are the drawbacks of this vehicle.

Another alternative, tax increment financing (TIF), started in California in 1952. TIF uses future gains in taxes to finance current improvements that will create those gains. When a public project is carried out, there is an increase in the value of surrounding real estate, often accompanied by investment in new or rehabilitated buildings. This increased site value creates more taxable property, which increases tax revenues. The increased tax revenues are the “tax increment,” which is dedicated to finance debt issued to pay for the project. Many localities use TIF bond proceeds as a primary source to pay for new infrastructure to attract developers and commercial enterprise.

Every U.S. state, except Arizona, has passed enabling legislation for TIF. Proponents say that TIF is a lifeline for local governments reluctant to raise property and sales taxes in the face of substantial declines in federal grants and subsidies. On the plus side, owners of properties who benefit directly from infrastructure improvements pay for them over time in higher tax assessments. On the downside, bond holders carry the risk that tax assessments don’t cover debt service, and local governments need to be concerned about the impact of potential defaults on their overall credit ratings.

Impact Fees

Impact fees are paid by developers out of their own pockets. Local governments increasingly are requiring them for infrastructure extensions and improvements into non-TIF projects, especially new developments. Since builders add this to the sales price, they lose the money if projects don’t sell.

These funding alternatives have a drawback: they do not pay for maintenance or repairs of infrastructure systems after they are built. Those costs typically must be covered by property and sales tax revenues raised by the county or municipality.

Following the Leaders

While America can claim first place in many of life’s arenas—business, lifestyle, pop culture, technology—it is not a world leader when it comes to finding infrastructure financing solutions. Other countries are leading innovation.

Margaret Thatcher pioneered the public-private partnership concept in the ‘80s with the privatization of Britain’s water facilities. Public- private partnerships (P3s) typically rely on long-term contractual relationships between government agencies and private-sector partners for the provision and operation of an infrastructure asset. P3s are now being used to deliver new and refurbished roads, bridges, tunnels, water systems, schools, defense facilities, and prisons.

Today, close to one hundred P3 projects are initiated or completed annually in Britain. In India, $47.3 billion is scheduled to be invested in highways alone over the next six years, 75 percent of it coming from public-private partnerships. Japan has 20 new P3 projects in the pipeline. In Europe, the volume of P3 deals is doubling, tripling, and even quadrupling year to year in many countries, according to a Deloitte Research Study on public-private partnerships.

Tolls and the Privatization Wave

“Toll roads were here before the interstate trust fund,” says PBS&J’s Tom Delaney, associate vice president & division manager, national tolls technology. “In fact, the interstate highway was originally planned as a toll road. When the alternate scheme for gas-tax funding was accepted, the issue of maintenance wasn’t adequately addressed. Operational funding was left up to the states.”

In 2005, the passage of the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU), gave tolling a boost, since it allowed, with certain restrictions, tolls on existing interstate facilities. Spurred by rising congestion, lack of federal funding, and better toll collection technology, 32 of 50 states now operate or are considering toll roads. Even so, Delaney notes, revenue is not growing proportionate to costs and operators can’t address immediate needs.

Faced with these pressures and strapped for cash, in 2005 Chicago became the first U.S. municipality to mimic its European counterparts in entering into a public-private agreement for the operation of the Chicago Skyway.

“Spanish tollway concessionaire Cintra, with the Australian bank Macquarie, won the first major ‘brownfield’ [existing facility] concession deal in North America in early 2005 with the Chicago Skyway,” says Phil Miller, a PBS&J tolls project director who worked with his colleague David Burgess to provide a brief due diligence review of the legacy toll system. The Chicago Skyway lease provides Cintra and Macquarie’s operating company a 99-year toll concession for the lease period in exchange for a one-time, up-front payment of $1.8 billion, Miller noted.

Perhaps even more noteworthy is the subsequent leasing of the Indiana Toll Road in June 2006. The Governor of Indiana used the concession bid process to raise money for a $2.7 billion, 10-year program for a major improvement of Indiana highway infrastructure by offering a 75-year lease of the 156-mile interstate toll highway between the Chicago Skyway and the Ohio Turnpike.

The Cintra-Macquarie team was again successful. “The team submitted the winning bid of $3.85 billion for this concession, which easily met the Governor’s funding needs, while also providing for extra local-roads-funding for the counties impacted by the toll road lease,” explains Miller. Not only is Indiana the only state with a 100 percent-fully-funded, long-range capital program for highways, but the state of Indiana is also earning interest on this “transportation endowment,” which can fund further transportation improvements.

States Embrace P3s

These two deals opened the floodgates. More than half the states now have P3-enabling legislation on their books. Texas, Virginia, and Florida have been especially active. Texas is relying on this approach to develop the Trans Texas Corridor, a massive new statewide transportation network that includes roads, commuter and freight rail, and utilities infrastructure. Virginia is negotiating P3s for several new projects, including the Dulles Rail Corridor, high occupancy toll lanes, and reconstruction of tolled truck lanes. The Commonwealth of Pennsylvania is conducting a bid process for a concession to operate the 560-mile, 67-year old Pennsylvania Turnpike. Estimates coming from all quarters peg this deal at a potential of $12- $18 billion, or perhaps more.

“Not every project should be a P3,” asserts Vic Poteat, PBS&J national toll practice director. “If a public agency has the bonding capacity and resources to deliver a major project and remain within its debt parameters, then that may be preferable. However, many projects, because of size and complexity, would come out ahead with private participation.”

Successful P3s, he says, can offer benefits such as: on-time/within-budget delivery; shifting construction, maintenance and operations risk to the private sector; lower construction and reduced life-cycle maintenance costs, and lower costs of associated risks; accelerated infrastructure construction; enhanced customer service orientation; and freedom for the public sector to focus on outcomes and services rather than the processes of construction and maintenance.

An Array of Alternatives

Enlightened Tolling

The attractiveness and popularity of toll road investments have been enhanced by the willingness of state legislatures and public authorities to recognize the need for periodic toll increases to keep up with inflation.

Traditionally, state legislatures and toll authorities often let tolls remain unchanged so long as receipts covered existing bond repayment obligations and current operating expenses. Now, inflation-indexed tolls, first introduced in the long-term concession agreements for the Chicago Skyway and Indiana Toll Road, and recently adopted in Florida by legislation, will allow future toll roads to be placed on a more businesslike basis.

Contributing to the public sector’s embrace of tolling has been the agreement by private toll concessionaires to accept availability payments and toll revenue-sharing as methods of compensation. From the government’s perspective, these arrangements have several advantages over outright concessions. They allow the state to retain the toll revenue—an arrangement that is politically more defensible than letting a private concessionaire keep the toll proceeds. Second, by tying payments to the volume of traffic, the state creates a profit incentive for the private concessionaire to manage the facility efficiently and attract a maximum number of customers. Third, the state owes money to its private-sector partner only to the extent the facility generates revenue. If traffic is lower than forecast, the private partner bears the risk.

Enter the Bankers

The growing acceptance of automatic toll increases is a key reason for the latest development in infrastructure funding: investment by private capital markets. Awash in cash—some estimate $100 billion—global investment banks, private equity firms, and institutional money managers are looking to place money from pension funds, insurance company general accounts, and high net-worth clients in infrastructure investments—the new “asset class.”

Multibillion-dollar CalPERS, the nation’s largest public pension fund, may have been the harbinger of the new mind-set when it announced in September 2007 that it was creating a $2.5 billion pilot infrastructure program focusing on investments in new roads, bridges, airports, and other utilities.

“The two biggest markets in the U.S. for infrastructure investment are transportation and water,” says Vic Poteat, “because they are big, stable facilities that will always be needed by the public. Therefore they give investors exactly what they want: long-term investment vehicles with stable returns.”

In its report on global infrastructure, the Urban Land Institute quotes bankers commenting that “the best opportunities for mature assets are in North America” and “the U.S. has to do something—they have a need and there is capital demand.”

With legislation enabling private market investment in infrastructure in 28 of the 50 states, U.S. markets are receptive.

John R. (Woody) Wodraska, national director of water resources at PBS&J, adds to that observation: “Toll roads are initially the more attractive investment. There are more toll roads being built than private water systems, and investors chasing big returns can get, maybe, 14 percent. But toll roads depend upon users, who may cut usage when the cost of gas rockets. On the other hand, people always need water. So while investment in a wastewater plant may yield 8-10 percent, that return is incredibly consistent, even in bad times.”

Wodraska and PBS&J assisted AIG in their AIG Highstar Capital Fund, a mutual fund focusing on utilities and infrastructure. “This kind of investment is the emerging market,” he says, “where water is increasingly on everyone’s mind. Some say Water is the Oil of the 21st century.”

One of the reasons for the lag in the water arena, says Wodraska, is that “water captures a different emotion from transportation. We drive on roads when we need to, but water is something we drink every day. It affects our kids. Privatization has such negative connotations that when dealing with public health, we don’t want a cost-conscious private provider. On the other hand, we know how inefficient the public sector can be. The bankers have the freedom to be creative on the transportation side. Whoever figures out the right financing vehicle for water investment will be the big winner. We’re waiting for that next best thing.”

Possibly all of our government officials, knowing the staggering costs needed to repair the networks that support society, and the impossibility of raising these sums in the near future, are hoping too for the one magic solution. Of course, there is none. With emerging powers like China—which spends 9 percent of its gross domestic product (gdp) on infrastructure—and India—which budgets 3.5 percent ($25.5 billion) while aiming to increase its allocation to 8 percent—upping the demand for the raw materials of construction, costs will only continue to rise. Most experts agree that the real fix for America’s crumbling infrastructure—for which we budget $112.9 billion or just 0.93 percent of our gdp—comes down to reassessing how we design our communities and transport our people. While we need new financial tools, we also need to look at new social paradigms. In the meantime, our infrastructure is ailing, and people are hard at work figuring out how to help it recover.