Insights on Federal, State and Local Transportation Funding from

Associate Director for Finance and Business for the American Association of State Highway and Transportation Officials Joung Lee briefs Reason Foundation

The United States transportation sector faces a perfect storm of increasing needs and dwindling resources. Over the past five years numerous panels and blue-ribbon commissions have been created to study how to fund the nation’s transportation system. There is no shortage of transportation proposals. However, many of the proposals are unrealistic or politically impossible.

This February 2012 interview with Reason Foundation’s Baruch Feigenbaum and the Associate Director for Finance and Business for the American Association of State Highway and Transportation Officials (AASHTO) Joung Lee discusses the association’s views on transportation funding priorities, current funding mechanisms and funding options offering the most potential over the next 20 years.

According to Lee, generally AASHTO favors a robust mix of transportation options including gas taxes, vehicle miles traveled (VMT) taxes, bonds, Transportation Infrastructure Finance and Innovation Act (TIFIA) loans, toll-roads and public private partnership. AASHTO wants to provide states the maximum flexibility to choose the funding and/or financing option best for each state. And AASHTO is against federal restrictions on tolling or VMT fees.

Baruch Feigenbaum, Reason: Our primary funding resource, the federal gas tax, no longer provides a steady stream of revenue for several reasons. First, a small but significant portion of the tax supports transit and non-motorized transportation projects. Second, the tax is not indexed to inflation. The same $18.4 cent tax yields significantly less than in 1994. Third, vehicles are becoming more fuel-efficient. Is the gas tax still the best funding option? Is there another more optimum solution?

Associate Director for Finance and Business Joung Lee: With increasing political gridlock in Washington, there is no one optimal solution. There is no perfect funding mechanism. AASHTO believes a mix of funding sources including gas taxes, VMT fees, bonds, PPPs and toll-roads is the best approach.

Feigenbaum: Is making changes to one transportation funding stream more realistic than making changes to another?

Lee: In years past, changing the gas tax was considered easier than changing other mechanisms. Today, making any financial change is difficult. Recently several legislators in both parties have suggested either increasing the gasoline tax or indexing it to inflation. This will be a hard sell to Congress and the president.

Feigenbaum: Researchers have suggested more than 20 different funding streams. I want to ask you about some of the most common. Please detail the funding streams and the advantages and disadvantages of each one: Increase the gas tax by 10-15 cents

Lee: Increasing the gas tax is easier than implementing a new funding mechanism. It is a long-standing successful revenue stream. The administration costs are low and the yield per rate change is high. For example, increasing the tax by one cent for both gasoline and diesel raises $1.8 billion per year. At the same time, with increasing fuel-efficient vehicles, the tax will not collect as much per cent as in the past. The gas tax is also somewhat regressive.

Feigenbaum: What are the advantages, disadvantages and potential revenue from indexing the gas tax to inflation?

Lee: This would raise revenue, but is politically challenging. One component of SAFETEA-LU (the last major transportation bill) suggested indexing the tax to inflation but President Bush did not support it. This is a more a problem at the federal level; many states’ gas taxes are indexed to inflation.

Feigenbaum: What is the potential of VMT fees?

Lee: VMT fees have a lot of potential. First, they are as technically perfect a user fee as you can get. They do a stronger job of paying the actual costs of travel than fuel taxes. (With fuel taxes the amount a motorist pays depends on the fuel-efficiency of his vehicle, not how far he/she travels.) There are some privacy issues, but since people do not seem to mind being tracked on their smart-phones the privacy issues especially for the younger generation may not be as big a problem. The biggest problem may be the administration costs. Estimates range from 15% to 40% of the total amount collected will go towards administration. There are 200,000,000 drivers and each one will need to have an account. Contrast this with the fuel tax that only requires the 1,400 fuel distributors across the country to have accounts.

There are several ways to design a VMT system. The first possibility is a national system created on the federal level. This system requires a political will that is currently lacking. The second system is a state or regional system. Oregon and Iowa have completed trials. A group of states such as New England could also participate in a trial. The third system would be a private industry taking leadership. While each option has pluses and minuses, the third possibility is the most intriguing. Potential customers seem less concerned about private industry having access to their personal information than the government. This system allows a voluntary opt-in and could offer location-based features that offer additional benefits.

Feigenbaum: What is the potential of value capture for funding transportation projects?

Lee: value capture is an underutilized mechanism that can work for both highways and transit. There are different types of value capture systems. (Some types involve capturing added property benefits of new highway or transit lines to fund these improvements.) The costs are more evenly distributed among the general public. Obvious opportunities might be in privatizing rest areas (adding restaurants and gas stations) to fund highway improvements or more expansive local bus service.

Feigenbaum: What are the advantages of TIFIA loans?

Lee: The biggest advantage for TIFIA loans is that the cost of capital does not get any lower. The cost matches the Treasury rate; the loan comes subordinated at this very low rate. TIFIA loans have ten times the amount of leverage of other loans. TIFIA loans are different from loans by a commercial bank that by nature has a profit motive. There are negatives. With any loan there has to be some sort of revenue stream. Also, we do not want TIFIA to become a geographic issue in which only certain states take part. This will turn it into a political issue.

Feigenbaum: Recently Congress has proposed raising the TIFIA federal share from 33% to 49 or 51%. Is this a good or bad thing for the program?

Lee: Overall it is probably a negative although there are advantages and disadvantages. With a higher federal share, project sponsors need smaller amounts of other financing types. This may open the program to certain types of projects where it was not previously realistic. However, increasing the federal share would also diminish the leverage of the program. And although it is cheap debt, it is still debt. Some participants may become too dependent on TIFIA loans taking on more debt than they can support.

Feigenbaum: Could you explain what Section 129 loans are?

Lee: Section 129 loans are most similar to state infrastructure banks in that they take advantage of capital to make loans to projects. As with other loans, too much debt can be problematic. These loans are not popular; states have not used them as much as proponents had hoped due to economic conditions.

Feigenbaum: How can toll-roads be helpful for funding transportation projects?

Lee: Toll-roads provide many advantages. With traditional revenue not what it used to be, and the political challenges of raising the gas tax, there is an urgency to find different revenue sources. Toll-roads can be a major part of the challenge. The key is for federal policymakers to provide maximum flexibility. If a state wants to build new toll-roads or toll reconstructed interstate highways that should be a state-level decision. Any national bill that prohibits tolling is not helpful. Tolling can be further supported by innovative financing tools.

Feigenbaum: What is the purpose of the National Infrastructure Bank (the actual infrastructure bank, not to be confused with the loan program proposed by President Obama)?

Lee: A case could be made for a National Infrastructure Bank. Currently the TIFIA program serves many of the same purposes for the transportation sector. A National Infrastructure Bank could support national and regionally significant problems with lumpy cash flows that cannot be handled by one state or one agency. For the program to work, Congress would have to create an independent agency. But Congress and the White House have little incentive to create such an agency because they would be outsourcing their control and influence.

Feigenbaum: Would proposing additional grant programs help with funding?

Lee: Whether creating more discretionary grants programs is a positive or a negative depends on how you view funding. In the past, because the United States is a diverse country we have tended to favor formula grants that provide flexibility for local governments to spend federal dollars in different ways. While discretionary grants programs like the transportation investment generating economic recovery (TIGER) grants have created an analytical selection method (at least in theory), these programs are heavily influenced by politics.

Feigenbaum: What are the differences of bonds such as grant anticipation revenue vehicle (GARVEE), grant anticipation note (GAN), general obligation (GO), limited/special tax, hybrid and private activity (PAB)?

Lee: Bonds are based on a matching flow of capital similar to a home mortgage. Similar to other financing tools there are risks and rewards. For bonds to be the best option there has to be a pressing need for the project to be delivered immediately versus ten years from now. Bonds require a portion of the government’s future revenue stream. Some states have over-extended themselves in bonds. In New Jersey, 100% of the state gas tax services bond debt.

GARVEE’s and GAN’s are debt-financing instruments with the pledge of future federal-aid for debt service. This financing mechanism generates up-front capital for highway or transit projects. Revenue bonds are used to finance municipal projects that generate revenue. General obligation bonds are issued for municipal projects that do not generate revenue and backed by the faith and credit of the issuer. Limited and special tax bonds are payable from a pledge of the proceeds against a specific tax. Hybrid bonds have characteristics of both revenue and general obligation bonds. Private activity bonds allow private-sector activity including development, design, finance, construction, operation and maintenance while maintaining the tax-exempt status. Tax credit bonds are a debt instrument where investors/bondholders receive federal tax credits instead of cash interest payments.

Feigenbaum: What are AASHTO’s thoughts on transportation regional infrastructure project (TRIP) bonds?

Lee: AASHTO is a big supporter of these bonds because they do not have the weaknesses of some of the traditional bonds. TRIP bonds use the tax code to target investments that provide grant-like qualities. TRIP bonds can allow the issuer to decouple the tax credit from principal. Interest payments are not required, and states would provide a twenty percent match. TRIP funds could provide a twenty percent match. Authorizing TRIP bonds could provide an average of an additional $500 million per state. In this situation the tax-credit to bondholders will be provided from revenues foregone by the federal government. The estimated cost to the federal government for such a program is $1.2 billion per year for the first ten years. Currently, AASHTO recommends that general revenue support TRIP bonds. AASHTO is also examining whether transportation user fees could support TRIP bonds.

Feigenbaum: How does non-profit 63-20 financing work?

Lee: This is a special entity that can fund certain projects. In traditional public/public funding mechanisms tax-exempt bonds can be issued by only the public sector. But 63-20 financing could provide benefits accorded to the public sector to private entities allowing added flexibility in financing. The most similar financing program is private activity bonds.

Feigenbaum: What are AASHTO’s thoughts on public-private partnerships (PPPs)?

Lee: PPPs provide maximum flexibility through innovative financing tools, management efficiency, private management of risk, private management advantages of the private sector, combined with the job creation and the social responsibility of public sector. PPPs can also speed-up the delivery of construction projects. General revenue funds supporting availability payments can provide some of the most flexible options. The biggest issue is the lack of institutional knowledge in the public sector. While PPPs are not appropriate for all projects, PPPs are a great opportunity for entities that are creative enough to use them.

Feigenbaum: What is the likelihood of a national sales tax dedicated to transportation?

Lee: This has been a non-starter on the federal level. While it would provide a valuable stream of revenue, many states use this tax and do not want the federal government to become involved. Sales taxes are one of the most regressive taxes.

Feigenbaum: On the state level which of these taxes we’ve discussed, or other revenue streams, are the best funding options?

Lee: Registration and license fees are popular mechanisms at the state level. They provide a broad revenue base. But they are blunt, imperfect tools as everybody who owns a car pays them with no relationship between the number of miles somebody drives and the license fee that they pay. The federal government could also impose a fee piggybacking on states, but most states prefer that the federal government stay out. User fees related to transportation such as gas taxes and vehicle-miles traveled fees provide a better relationship between how many miles somebody drives and how much they pay. State infrastructure banks also have potential. These state banks operate in one of three ways. Some states such as South Carolina have banks that are capitalized only by state transportation funds. Other states such as Ohio have banks capitalized by both national and state funds. Still other states have banks capitalized only by federal funds. More than 30 states operate some forms of infrastructure bank. Some states charge fees on tires, oil, or other car necessities. These fees are more related to the total miles traveled than license fees but less so than gas or VMT fees.

Feigenbaum: Do swings in the economy determine if one funding mechanism is better than another funding mechanism?

Lee: Debt financing can make more sense in recessions because the interest rates are much lower, although the funding to secure the debt may be easier to obtain in a stronger economy. User fees provide a good funding mechanism in all economic conditions.

Joung Lee is the Associate Director for Finance and Business Development. Previously Mr. Lee was the Senior Analyst for Transportation Finance and Business Development. Before working for AASHTO Mr. Lee was a Transportation Planner at the Federal Highway Administration. Mr. Lee has a Masters in Governmental Administration for the University of Pennsylvania and Bachelor’s Degree in Urban and Environmental Planning from the University of Virginia. Mr. Lee also founded the Young Professionals in Transportation group in 2008.

AASHTO originally set technical guidelines for highways creating the engineering specifics and numbering system for the interstate highway system. Over the last forty years the organization has broadened its mission to include Policy, Finance, Government Affairs, Public Transportation, Rail, and Aviation.

Baruch Feigenbaum is a transportation policy analyst at Reason Foundation.