Infrastructure: The Grand Bargain

Discovering solutions to ongoing infrastructure project needs by addressing funding concerns

By Manuel H. Lazerov

There is widespread political agreement on upgrading and expanding the nation’s infrastructure, estimated at $9 trillion. The only question is who allocates the money and has control. That is important because those choices affect power, influence, profitability, votes and prestige — and, on the downside, risk.

Financing is not the central issue. Funding is – that is, the willingness of the public to pay for it. The fact that our infrastructure is falling apart indicates that there is plenty of public resistance to more debt and deficits, higher taxes and user fees. Public resentment about paying for new infrastructure and upgrades runs high. Consequently, it is a must, whether done publicly or with private investment, that strong public official leadership is at the forefront in convincing taxpayers of the need for specific projects.

The Grand Bargain will be a combination of government resources and private investment in public infrastructure, having to do with financial capabilities, the tolerance for risk, etc. One set of parameters to keep in mind is the Administration’s infrastructure proposal, and the latest tax legislation. Basically, the Administration envisions their putting up $200 Billion over a 10-year period, which would be matched by state and local governments putting up over $800 Billion through the sale of existing infrastructure assets, higher debt and taxes, and user fees. Given the fiscal condition of many jurisdictions, private investment may very well be their best solution.

Funding for infrastructure by the Federal Government has reached an inflection point; it will become increasingly limited in the future at the state and local level. The Federal Government will not be riding to the rescue of state and local governments. The latest tax legislation was passed with an agreement that limits future deficit spending.

Congress also faces elections with greater frequency than local officials. Wishing to be seen as fiscally responsible, and having increasing difficulties in sustaining existing programs, Congress will be reluctant to initiate any new major spending programs.

How some decisions might get made

A simple formula Virginia has a simple formula for determining who does a particular road project. The state first makes an estimate of what it would cost them to do a project and then invites tenders. If private investors can do the project for a predetermined percentage less than the state, Virginia will do it with them.

Risk as a consideration– A public decision could depend upon a lack of familiarity with a specific type of project, the size of the financial commitment, budgetary and statutory limitations, and the uncertainty about profitability. On a more basic level, concern with the risk may be over controlling construction costs, operations and maintenance, the overall management of the project itself, and feasibility.

Public officials can shift risk by using a Guaranteed Maximum Price contract for construction and even for O&M. That, however, will require governments changing from a Design-Bid-Build arrangement to a Design-Build contract, where the adversarial element is removed, making the developer fully responsible for design flaws. Extras are only the result of a change in scope of the work requested by the government.

Many contracts provide for the transfer of the infrastructure in good condition to government after the end of a concession. This eliminates the reliance of the executive branch upon the legislature to appropriate adequate funds for O&M or to raise user fees to maintain a project.

Money is of no concern– This has been true in some instances, especially at a local level where the Federal Government has been funding the lion’s share of a construction budget. Historically, that is the proportion of what the Federal Government has funded, leaving the local government to pick up the O&M thereafter.

Recently, however, the president indicated that future federal funding would be dependent upon local governments, proving their projects are feasible and economically sustainable. That means that the construction and O&M, and any debt must be able to be supported by revenues, either by user fees and taxes. Whether or not the Federal Government will require guarantees from local government to do what is required to fully maintain and put aside a reserve fund for replacement of those assets in the future has yet to be spelled out.

O&M on a life cycle basis are generally 10 times that of original construction costs. The cost of capital has to be added to that, all of which changes the level of concern, from just getting a project built to appreciating the nature of such long-term commitments.

Incentivizing infrastructure– It is unlikely that there will be a coordinated national infrastructure program, like those found in Canada, Europe and Australia. Federal projects will continue to be developed as they have been. At the state and local level, the processes will continue to be fragmented, with diverse pieces of enabling legislation, or no Public-Private Partnership laws at all in a number of states, which would mean that projects will be developed under each jurisdiction’s existing procurement laws, or be developed by the jurisdictions themselves.

Indications are that private investment will only account for 20 percent of the money for future infrastructure improvements, with state and local governments using a combination of incentives to attract economic development, like the recent Amazon headquarters projects in Virginia and New York.

Manuel H. Lazerov is the President of Infrastructure Financial, Inc. He can be reached at lazerov@InfrastructureFinancial.org

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