Thinking Beyond the Gas Tax

Kenneth Orski's picture
"We must respond to the reality that the gas tax, the traditional source of revenue for transportation investments at both the state and federal level, is not expected to keep pace with transportation needs in the future." With these words, New York Transportation Commissioner Astrid C. Glynn welcomed participants to a New York State DOT-sponsored symposium, "Beyond the Gas Tax: Funding Future Transportation Needs." The event, organized by Prof. Robert (Buz) Paaswell, Director of the University Transportation Research Center at City College of New York, drew some 200 participants to Syracuse N.Y. on October 7. Emil Frankel, former Assistant Secretary for Policy at the U.S. Department of Transportation and currently head of the National Transportation Policy Project at the Bipartisan Policy Center, gave the keynote address. He was followed by a group of national and state speakers who examined the status of state and federal transportation finances and explored the funding options for the future.

A sober assessment of the present state of the financial markets was offered by a senior Wall Street executive highly knowledgeable in transportation financing. The full spectrum of debt-funded infrastructure funding alternatives is under pressure, he reported. Most states are in a massive budget review as the impact of reduced revenues is beginning to emerge. Credit spreads have widened significantly and the overall borrowing costs, including Private Activity Bonds, have increased appreciably. There has been a record postponement of new bond issuances and a cancellation of at least one proposed PPP deal, the $800 million Missouri Safe and Sound Bridge Improvement Program --victim of the changing credit market conditions. Looking to the future, the Wall Street executive saw a changing capital market, with more costly municipal financing and severely constrained bank financing driving down valuations and reducing the number and size of projects.(However, in a follow-on discussion, the executive saw a ray of hope--several municipal bond deals totalling in excess of one billion dollars have come to market in the last few days, albeit at elevated interest rate yields).

In our own remarks as moderator of a panel on "Options Beyond the Gas Tax" we took a longer view. The text of our remarks follows.

We have been asked to discuss in this panel session "options beyond the gas tax," but this should not be construed as a requiem for the gas tax. To paraphrase Mark Twain, the reports of its death are greatly exaggerated. The gas tax has served us well for the past 50 years and it will continue to provide us with a steady source of revenue for a good many years to come. At least $40 billion in federal gas tax money will continue to flow to the states annually in the years ahead. I am aware of the recent decline in vehicle miles traveled (VMTs) and gas tax receipts as reported earlier in this conference, but I take the long view. Sooner or later the financial crisis will pass, confidence will return, the recession will end and the revenue losses will be erased.

Still, to rely on the gas tax as the sole source of investment capital for transportation infrastructure --especially new infrastructure -- is no longer thought to be a realistic assumption. Such, in essence, was the considered judgment of a great majority of participants in a survey that we conducted not too long ago. State officials told us they are obliged to commit a major part of their tax-supported transportation budgets to preserving, modernizing and replacing existing infrastructure, leaving little money for new construction. What's more, higher gas prices are causing people to drive less and buy more fuel-efficient vehicles - and this will leave even less revenue for capital investments in the days ahead. As Allen Biehler, Secretary of PennDOT stated recently. "We are struggling to have enough money to hold together what we have, let alone be able to think about the level of investment that would be needed to provide new infrastructure." I think Commissioner Glynn and many of her fellow DOT commissioners could readily identify with this assessment.

To be sure, a boost in the federal gas tax is not off the table - in fact it is almost certain to be part of the surface transportation authorization proposal next year. But any modest boost in the federal gas tax---and only a modest increase has a chance of passing muster with the congressional tax writing committees and obtaining a filibuster-proof majority support in the Senate--will be consumed by ever-growing demands for maintenance and preservation of the Interstate System and other parts of the highway network. It will leave little revenue to invest in new facilities. Moreover, an increase in the federal tax would go only part way toward a solution. That's because the federal program contributes only about 40-50 percent toward the capital cost of transportation infrastructure. The remaining 50-60 percent has traditionally come from state and local budgets. There is no guarantee that states, including the state of New York, will be able to meet their part of the bargain through local tax increases---be it gas or sales taxes.

So I am led to conclude that any politically realistic increase in the gas tax will fall short of generating enough capital to fund major reconstruction of existing facilities or entirely new infrastructure. Instead, states will be obliged to look for new sources of capital. Where will the money come from? Again, I am taking the long view. As we heard earlier from Jim Calpin, at this point in time the credit markets are virtually frozen. But these conditions will not last forever. Eventually, liquidity in the banking system will be restored and infrastructure asset financing will resume, albeit on more conservative terms.

Some states will be able to fund infrastructure investments with borrowed capital - as California has done two years ago with its massive Strategic Growth Plan bond referendum. But many states will be foreclosed from borrowing funds in the municipal bond market because they will run into a statutory debt ceiling or because of citizen opposition to further bond indebtedness. At the very least, borrowing in the municipal bond market will become more costly. Even after the market returns to more normal conditions, the cost of borrowing will rise because the structured-finance instruments that formerly made borrowing less costly, will be replaced by the more expensive old fashioned fixed-rate bonds. On top of that, the sheer magnitude of the need for new infrastructure is likely to overwhelm the bonding capacity of most state and local governments.

Another option to generate new capital for infrastructure investments could be some kind of new federal financing initiatives that would create a de facto national capital budget for transportation projects "of regional or national significance." The most prominent financing initiatives considered in Congress today are the National Infrastructure Bank (NIB) and the Build America Bonds proposals. The NIB proposal has gained political traction by receiving the support of House Majority Leader Nancy Pelosi and presidential candidate Barack Obama and thus stands a good chance of enactment during the next session of Congress. But these revenue sources - $60 billion over 10 years in the case of the National Infrastructure Bank and $50 billion in the case of the Build America Bonds program - would be but a drop in the bucket considering the huge infrastructure gap that exists today--- $1.6 trillion according to the American Society of Civil Engineers (and that's just to bring the existing infrastructure into a state of good repair.)

All this suggests to me that a purely federal-centric approach---be it a gas tax increase or a federal capital budget, or even a combination of both---cannot by themselves make up for decades of under-investment and meet future demands for increased transportation capacity.

What we are likely to end up with instead is a hybrid funding approach. Part of it will be a modest increase in the federal gas tax. Another part may involve some kind of a new federal financing initiative - most likely a National Infrastructure Bank. But this will still leave a major portion of future additions to road capacity to be financed by toll revenue and the private sector. Private investment will most likely take the form of project-based private toll concessions. In New York State, the new Tappan Zee Bridge would be a prime candidate for such a concession.

Tolling and toll revenue financing of new highway capacity is being accepted by most states as a necessary and inevitable consequence of budgetary shortfalls and the limitations of the pay-as-you-go system of financing. By our count, a total of 22 states are contemplating the use of tolls and toll revenue bonds to support the expansion of infrastructure capacity. The technology of electronic toll collection (ETC) has made tolling user friendly and widely accepted by the driving public. ETC not only allows collection of tolls at highway speeds thereby eliminating delays at toll plazas; it also allows for the management of traffic flow through variable (congestion) pricing--- the technique that underlies the increasingly popular concept of HOT lanes.

Some states will choose the traditional approach of using tax-exempt debt and design-build contracts. But our survey showed that many other states will opt for private toll concessions financed with a combination of bank loans, private equity capital and Private Activity Bonds. Their motivation for partnering with the private sector is not entirely fiscal. It also includes a recognition of other positive benefits of private sector involvement such as access to equity capital, faster project delivery, ability to introduce innovation and to assume operating and financial risks.

There has been some speculation that private concessions might run into opposition on Capitol Hill when the federal surface transportation program comes up for a new authorization next year. But recent statements by Congressman De Fazio, chairman of the influential House Highways and Transit subcommittee, suggest that congressional lawmakers will not object to private toll concessions for new projects so long as PPP agreements contain adequate safeguards to protect the public interest. These safeguards could involve a cap on toll increases (or on the rate of return), prohibition on noncompete clauses, revenue sharing requirements, recapture of excess profits, prohibition against diversion of funds and limits on length of concession agreements.

Availability of private funding will depend, of course, on the willingness of the private sector to invest in public infrastructure assets. On that score, there seems to be little doubt. While the age of highly leveraged deals such as the Indiana Toll Road concession may be over, there are still billions of dollars in domestic and foreign infrastructure funds waiting to be invested in transportation facilities. Toll roads appeal to long-term investors such as pension funds because they generate strong demand even in times of slower economic growth and produce steady and predictable cash flow relatively unaffected by economic downturns. And pension funds require stable, income-oriented investments to match their long-term liabilities and payout obligations. Given the current volatility of the equities market, the low interest rates of the government bond market and the risky nature of investments in corporate credit instruments and real estate, infrastructure is now seen as a "safe haven" for long-term investors, a senior bank official told us. Financial News calls it "a rare bright spot in a tumultous market." Again, I am aware of the current decline in toll revenue (caused by reduced VMTs) which makes investment in toll facilities less attractive, but I consider this a cyclical phenomenon tied to a recessionary economy. In the long run, toll roads have lost none of their revenue earning potential.

However, the future of PPPs depends on how private investors will perceive the expected government oversight placed upon private participation. If the capital market should conclude that legal restrictions and regulatory barriers placed on private concessions are too onerous and burdensome, investors (especially foreign investors) may decide that investing in U.S. infrastructure is not worth the trouble and they will turn instead to infrastructure investment opportunities abroad. That, in my view, would be most unfortunate for it would deprive fiscally strapped state and local governments of a much needed source of capital to modernize and expand America's infrastructure.

In the long-term, we must find the means not just to supplement the gasoline tax but to replace it with a more stable source of revenue. The most likely candidate appears to be a mileage tax (VMT fee), i.e. a fee based on trip length and possibly vehicle size and weight. Such a revenue system would reflect more closely the actual usage of the road system and would not rely on taxing a commodity whose use we are actually trying to discourage. It is possible that a VMT fee will be phased in progressively, with commercial trucks being the first to be subject to it. With many trucking concerns already using the Global Positioning System to monitor and track their trucks' movements, a mileage fee for commercial trucks could be introduced relatively quickly and with fewer complications. Precedent for truck VMT fees already exists. A satellite-based mileage fee system for heavy trucks, called TollCollect, has been operating successfully in Germany since January 2005. There are currently 640,000 vehicles equipped with TollCollect transponders. Last year they generated $5.15 billion in fees. But a mileage-based revenue system in this country is for the long term. Estimates range between 10 and 25 years before a VMT tax is fully tested and ready to be implemented nationwide. In the meantime, we must devise other ways to supplement the inadequate stream of revenues from the gas tax.

In welcoming us to the Symposium, Commissioner Glynn noted that the gas tax, the traditional source of revenue for transportation investments, isn't keeping pace with the State's growing transportation needs. I hope my presentation has made it clear that there do exist other funding options, not the least of which are toll revenue bonds, private equity capital and the mechanism of public-private partnerships. I was pleased to note that the potential of PPPs to contribute to New York State's fiscal situation will be investigated by a special study commission headed by Deputy Secretary Charlotte Hitchcock. In announcing the Commission, Gov. Paterson said, "Public-private partnerships offer an opportunity for the State to more effectively make long-term capital investments, even in a period of economic distress" (italics added). His endorsement of PPPs at this critical time will be greeted warmly by all advocates of private investment in public infrastructure.
C. Kenneth Orski is editor and publisher of Innovation NewsBriefs, an infuential and widely read transportation newsletter



Michael Lewyn's picture

And of course, politics matters here

Not so much in the sense of Republican vs. Democrat, but in the relationship between highway and transit advocates. If highway and transit advocates want to work together (as they have done at the federal level over the past decade), they can make some of these financing reforms happen.

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