Making sense of the many infrastructure financing ideas currently being discussed can be confusing. Many distinct funding and financing options are lumped together under the “finance” heading, when in fact they are different mechanisms that will yield different results. Some examples of financing proposals include tax credits, public-private partnerships, private activity bonds, and a national infrastructure bank. These proposals differ from the traditional approach the federal government has taken, which is to provide state and local communities with direct funding (i.e., grant dollars) targeted to a particular infrastructure sector such as highways or water.
To craft an infrastructure package that meets America’s broad needs, policymakers will have to determine the appropriate balance between funding and financing and choose from among the various ways to accomplish each. These FAQs are intended to provide a basic overview of key concepts in infrastructure finance.
To craft a package that meets America’s needs, policymakers will have to determine the right balance between funding and financing.
Q: What’s the difference between funding and financing?
A: When it comes to federal support for infrastructure, there is an important distinction between funding and financing. Funding provides a project with cash that does not need to be repaid. For example, federal grants are considered funding; the federal government spends the money for the project to get built, with no expectation of being repaid. Financing is a mechanism to provide cash to build a project today, but that cash is borrowed and will need to be repaid with interest in the future. In the past, financing has primarily come from private investors who purchase bonds (see explanation of bonds under the next question) or invest directly in a project, but more recently the federal government has also offered financing programs as well as direct funding.
Funding for large infrastructure projects is typically not available to cover the full cost of the project at its start. State and local agencies use financing to get the upfront cash needed for the project. The investors who provide the financing expect to be repaid, with interest, over time. Repayment can come from federal or state tax revenues, but it can also come from future user fees, dedicated sales taxes, new tax revenues that result from the project (e.g., increased economic activity from development), or other sources (such as revenues from concessions at rest stops or airports).
Both funding and financing play a critical role in getting infrastructure projects done. Financing allows projects to be completed faster—sometimes years faster than they could otherwise be done—and helps to spread the payments for an infrastructure asset over the life of the asset. Funding—from taxes, fees, or other revenue sources—is needed to repay financing.
Q: What is “innovative financing”?
A: In the infrastructure context, innovative financing typically refers to any type of financing other than standard tax-exempt municipal bonds. Tax-exempt bonds are issued by states, cities, counties, and other regional and local governmental or quasi-governmental entities to finance a range of public purposes, including infrastructure. Interest on these bonds is exempt from federal taxes, and therefore buyers of the bonds will accept a lower interest rate than they would for taxable bonds, since part of the income they receive on taxable bonds would have to be paid to the federal government. This reduces the cost of capital for local governments by lowering the interest rate states and local governments have to pay to investors. Tax-exempt debt is the primary way to finance infrastructure projects. And, since the vast majority of buyers of tax-exempt debt are private companies and individuals, tax-exempt debt is one way to bring private investment into infrastructure. The municipal bond market is robust, with more than $3.7 trillion in outstanding issuances currently.
In recent years, new financing options have emerged in addition to tax-exempt debt. These include federally-supported programs such as the Transportation Infrastructure Finance and Innovation Act (TIFIA), which offers low-interest loans and loan guarantees for transportation projects, and private activity bonds, which allow certain types of public-private partnerships to issue tax-exempt debt, giving more types of projects access to bonds with the same preferential tax treatment as municipal bonds. Some public-private partnerships use private sources of financing for projects. There are also emerging ways to structure debt like value capture—in which future increases in property tax revenues are pledged as repayment for a bond. Collectively these tools are known as innovative financing.
Q: Why do we need innovative financing?
A: America’s tax-exempt bond market is the envy of the world. It has financed trillions of dollars in infrastructure projects, from the roads we drive every day to our children’s schools to the water pipes that serve our homes. Still, there are reasons why a community might pursue other financing methods. Some places are concerned that taking on more debt could adversely affect their credit rating, which could make future debt issuances more expensive for them. There may be public or political opposition to taking on more debt, or a strict schedule for debt issuances that would delay the project by months or even years. Further, a few states and localities are at or near statutory debt limits. And, using other forms of financing can free up capital raised from prior debt issuances for other purposes. Innovative financing also draws capital from different types of investors; because of their tax-exempt status, municipal bonds do not attract investors who do not pay federal taxes anyway, such as pension funds, university endowments, and foreign investors.
Q: Are public-private partnerships a form of financing?
A: Sometimes. A public-private partnership (P3) can be a form of innovative financing, but it does not have to be. There are many types of public-private partnerships. At root, a public-private partnership is a different model for procuring services to design, build, and perhaps operate and maintain an infrastructure project. Many of these contractual arrangements involve private financing, but some do not.
In a typical infrastructure project, a public agency contracts with separate private companies to complete each stage of the project: design and engineering; construction; and sometimes operations and maintenance. In a P3, a public agency contracts with a single private partner (typically, a consortium of companies) to complete multiple stages of the project. Putting responsibility for multiple project stages into the hands of a single consortium can save time, encourage best practices (since the same consortium will build what they design, or operate what they build), and protect the public agency from risks, such as cost increases or schedule delays. As part of the contract, many P3s require the private partner to provide the upfront capital for the project, to be paid back over time from project revenues or payments from the public partner. When this is the case, P3s can be considered a form of financing. In very few cases do P3s actually provide private funding for a project.
Q: What does it mean to say we can leverage private dollars with public funds?
A: Innovative finance is often talked about as a way to “leverage private dollars” with public funds. This use of “leverage” is different from the technical financial meaning, which refers to the ratio of debt to equity in a project or investment. In the infrastructure context, leveraging private dollars means that an investment of public funds into a project is expected to attract private dollars to that project as well. This can happen in several ways. For example, a public agency may be working with a private consortium to develop a project, and neither the public agency nor the private partner has the ability to finance the entire project on its own. In that case, a low-interest loan from the federal TIFIA program might be able to fill the gap, allowing the project to move forward with private financing covering the rest. It might be said that the TIFIA loan “leveraged” the private capital for the project.
Tax credits for private investments in infrastructure are another way to use public funds to leverage private dollars. Under this type of structure, which has been proposed by President-elect Donald Trump as well as Sens. Ron Wyden (D-OR) and John Hoeven (R-ND), a private company will invest dollars directly in an infrastructure project, and will receive a credit on its federal taxes equal to a specified percentage of that investment. The public investment here is the revenue loss from the tax credit, but by providing an incentive for private investment, tax credits are expected to “leverage” a greater amount of private investment than they cost the federal government.
The white paper released by then-candidate Trump’s campaign also talks about leveraging private investments for infrastructure, but in that case, the term “leverage” is being given its technical financial meaning. Just as mortgage lenders require borrowers to put in a certain amount of equity when they buy a home, the white paper states that lenders who finance infrastructure will want to see a certain amount of equity in the project, to cushion their investment against potential losses. The Trump campaign paper assumes a debt-to-equity (or “leverage”) ratio of 5:1, which means that to attract $1 trillion of capital for infrastructure, the U.S. would need $167 billion in equity investments, with the remainder provided as debt. It further proposes that these equity investments would come from private companies, who would be incentivized to invest through a federal tax credit, which is a public investment measured in terms of revenue loss.
Q: Do funding and financing have different impacts on the federal budget?
A: Funding and financing are scored differently for federal budget purposes. Grant programs “score” at their full dollar amount, although the costs may be spread over several years. For example, a $100 million grant program would ultimately cost the federal government $100 million. Federal financing programs are scored differently. In the case of a loan program, the cost to the federal government is the amount of the loan multiplied by the risk that the loan will not be paid back. So a $100 million loan with a 10 percent default risk would “score” for federal budget purposes at $10 million. (For programs where federal support comes through the tax code, such as tax-exempt debt, the cost to the federal budget is recorded in terms of foregone tax revenue rather than as spending.)
For federal budget purposes, therefore, a program that provides infrastructure loans would have a smaller budgetary impact than a similarly-sized grant program. However, from the state and local perspective, federal loans are actually more costly than federal grants, as loans require interest payments and grants do not.
A public-private partnership is a different model for procuring services to design, build, and perhaps operate and maintain an infrastructure project.
Q: Is a national infrastructure bank funding or financing?
A: A national infrastructure bank is not inherently a source of either funding or financing. A national infrastructure bank could provide either funding or financing, or both, depending on what Congress authorized it to do. Congress could create a bank with the authority to provide grants (which would be funding) or loans and loan guarantees (which would be financing). Authorizing a bank to allocate private activity bonds among projects, something USDOT now does for transportation projects, would also be a form of financing support.
Q: If Congress decides to use repatriated corporate profits to pay for infrastructure, is that funding or financing?
A: Some in Congress have proposed using repatriated corporate profits to pay for federal infrastructure programs. Repatriation refers to a process in which companies that earn some of their profits overseas and therefore do not pay federal taxes on them would be encouraged to bring those profits back into the United States by reducing the tax rate the companies would otherwise have to pay. The goal is to incentivize companies to reinvest their profits in the United States while also raising revenue from the taxes paid on the “repatriated” profits. While some have proposed using that revenue to offset the cost of making other changes in the tax code, others have suggested using it to shore up the Highway Trust Fund (which supports roads, bridges, and public transportation and is facing insolvency) or depositing it into a national infrastructure bank.
If repatriated profits are in fact used to pay for infrastructure, the question of whether those dollars should be considered funding or financing depends on how Congress decides to use them. If those dollars are used to pay for grants, that is a source of funding. If they are used to support lending programs, that would be a source of financing. In other words, the “pay-for” that Congress uses for an infrastructure package is separate from the question of whether those dollars are used to fund or finance infrastructure.