For supporters of the use of public-private partnerships to procure highway projects, the massive $1.2 trillion Infrastructure Investment and Jobs Act (IIJA) was a mixed bag. Congress left in place the longstanding ban on tolling existing Interstate segments, but it also doubled the private activity bond (PAB) lifetime volume cap to $30 billion.
Additionally, two IIJA provisions require value for money (VFM) analysis (“or other comparable analysis”) could open the door for more procurements, although Reason’s Bob Poole highlights a possible implementation wrinkle with the VFM analysis provisions in the April issue of Public Works Financing.
But one important financing issue was ignored by Congress: the application of the alternative minimum tax to interest income from private activity bonds. Bringing tax code parity to PABs and governmental bonds would make PABs—and the public-private partnerships (P3s) that are in part financed with them—more attractive.
Under the federal tax code, bonds issued by state and local governments are broadly categorized as either governmental bonds or private activity bonds. Interest income on governmental bonds, such as municipal bonds, is not subject to taxation. In contrast, interest income on private activity bonds, as with commercial bonds, is generally taxed. Government-issued bonds are subject to two private business tests (26 U.S.C. § 141(b)). If both conditions are met, the bond interest income is generally taxable.
However, Congress has provided tax exemptions for some uses of private activity bonds. These are called qualified PABs. Most relevant to the infrastructure discussion are a subset of qualified PABs called exempt facility bonds. Relevant to this discussion is Section 142(m) of the Internal Revenue Code, exempt facility bonds for qualified highway or surface freight transfer facilities.
Since they were established for highway uses by the SAFETEA-LU (Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users) surface transportation reauthorization of 2005, qualified PABs have been very important in highway public-private partnerships.
As Reason Foundation’s Baruch Feigenbaum wrote:
In most cases PABs provide financing for 20-30% of the project’s total cost. For megaprojects, $12 billion in private activity bonds led to $45 billion in project activity over the past 15 years. Without PABs many of these projects would not have been feasible.
However, these bonds were also subject to a national lifetime volume cap of $15 billion by Section 142(m)(2)(A) of the Internal Revenue Code, and this had essentially been maxed out by 2020. Fortunately, the IIJA doubled this lifetime volume cap to $30 billion, buying at least a few additional years of robust P3 project activity. The additional $15 billion in qualified highway or surface freight PAB capacity provided by IIJA Section 80403 was badly needed to ensure government and P3 financing remained competitive. But IIJA failed to address a longstanding disparity between governmental bonds and tax-exempt PABs: the application of the alternative minimum tax (AMT).
The AMT is an income tax designed to ensure that taxpayers who take many deductions and exemptions pay a minimum rate of 26% or 28%, depending on the level of gross income. Interest income from governmental bonds is excluded from the AMT. In contrast, interest income from normally tax-exempt PABs is generally taxable. This tax code disparity raises the relative cost of financing a project under a P3 procurement. As the Congressional Research Service points out, “Because private activity bonds are included in the AMT, the bonds carry a higher interest rate (approximately 50 basis points) than do tax-exempt government-purpose bonds, all else being equal.”
The good news is there is a simple fix. Section 57(a)(5)(C) of the Internal Revenue Code could be amended to add new clause (vii):
(vii) EXCEPTION FOR PRIVATE ACTIVITY BONDS FOR QUALIFIED HIGHWAY OR SURFACE FREIGHT TRANSFER FACILITIES.—For purposes of clause (i), the term “private activity bond” shall not include any exempt facility bond that is issued as part of an issue to finance a qualified highway or surface freight transfer facility (as defined in section 142(m)).
As Congress conducts oversight of the implementation of the Infrastructure Investment and Jobs Act in the coming years, it should not forget that the private sector can play a positive role in building, financing, and managing public-purpose infrastructure like highways. Small tweaks, such as bringing alternative minimum tax exemption parity to the private activity bonds used in highway public-private partnerships, could go a long way.