Working to find actionable solutions to the nation's key challenges.

Two Birds, One Stone: Tax Reform and Infrastructure

By Sarah Kline

Wednesday, May 24, 2017

With the release of President Trump’s tax outline last month, the comprehensive tax reform debate is expected to heat up among the tax writing committees in Congress. It remains to be seen whether congressional and administration leaders can reach agreement on the many thorny questions involved in revamping our tax code. If legislation does advance, it will present a prime opportunity to address another pressing issue for our country: infrastructure.

Though America’s infrastructure is facing a growing crisis (the latest ASCE report card gave it a D+), it has so far been only tangentially discussed in the tax reform context, as a possible recipient of repatriated corporate revenues. Rep. John Delaney (D-MD), for one, has been relentless in the quest to help address infrastructure funding shortfalls through an infusion of repatriated cash. While helpful in the short run, repatriation alone is not a long-term solution. There are more ways in which tax reform legislation could positively affect America’s infrastructure.

  • Tax reform is the ideal context in which to identify and adopt long-term, stable funding sources for infrastructure. Many current funding sources are user fees established many years ago, which are now unable to keep up with demand. The federal gas tax, which supports highway and transit programs, has not been increased since 1993, and Congress has had to plug shortfalls in the Highway Trust Fund six times over the past nine years with general revenues. The Passenger Facility Charge that airports use to fund maintenance and capital expenditures has not been increased since 2000 despite numerous proposals in front of Congress. Other options for paying for infrastructure include vehicle miles traveled fees, container fees, customs fees, and various other types of user fees and taxes (see page 63, table 4.7). Authorizing new or increasing existing fees, or at the very least indexing them to rise with inflation, would go a long way toward more sustainably funding these programs. Yet, past efforts have shown that accomplishing that goal as a stand-alone measure would be politically challenging, making a comprehensive tax bill the better opportunity for addressing this critical need.
  • To further leverage federal investment in infrastructure, the tax committees would do well to expand financing support. Direct-payment bonds, such as the Build America Bond (BAB) program authorized from 2009-10, offer a taxable bond for which the issuer receives a direct payment from the federal government or the buyer receives a federal tax credit. Unlike traditional tax-exempt debt, direct payment bonds are attractive to investors who do not have federal tax liability, such as pension funds. However, the short-term nature of the BAB program made it difficult for projects that were not already well-developed to use them, and the fact that BABs were affected by the sequester undermined investor confidence. A new direct payment bond that could be used for conventional projects as well as public-private partnerships would attract the widest variety of private investors and support the greatest number of projects. Allowing the new bond to be converted into a tax credit, as proposed for private activity bonds by Sens. Ron Wyden (D-OR) and John Hoeven (R-ND), would provide additional flexibility.

The tax reform discussion presents a unique opportunity to finally address long-standing funding challenges and leverage additional private capital for infrastructure.

Several existing infrastructure financing tools are also embedded in the tax code, where favorable tax treatment is used to spur state, local, and private investment in infrastructure. The new direct payment bond described above should complement, not replace, these tried and true mechanisms:

  • Tax writers should continue to support the existing tax-exempt bond market. According to the National League of Cities, 87 percent of utilities, 65 percent of schools, 40 percent of healthcare facilities, and 35 percent of transportation projects are financed by tax-exempt bonds. These are mostly held by private individuals who can make use of the favorable tax treatment such debt provides. This form of private investment has built much of America’s infrastructure and is critical to solving our challenges going forward.
  • Private activity bonds (PABs) complement the existing tax-exempt bond market by extending favorable tax treatment to public-private partnerships (traditional tax-exempt debt is generally available only for publicly-owned and managed projects). However, unlike traditional tax-exempt debt, interest on PABs is currently subject to the alternative minimum tax, or AMT, which lessens the benefit of the tax exemption. The Wyden-Hoeven bill exempts interest on their new PAB, the Move America Bond, from the AMT. Amending the PABs program in accordance with their proposal would lower the cost of capital and encourage more public-private partnerships.
  • Real estate investment trusts (REITs) hold mostly real estate assets and earn mostly passive income (rent), allowing them to be taxed only at the shareholder level. REITs are already allowed to hold certain infrastructure assets including railroad lines, pipelines, communications towers, storage facilities, and prisons, though commercial and residential real estate are the most common holdings. REITs may have advantages over conventional infrastructure funds, including: liquidity, as REIT stock can be publicly traded; incremental scalability in raising capital; attractiveness to the entire range of institutional and individual investors; and certain tax advantages. REITs represent a well-understood vehicle to access capital markets and allow the public to participate in owning qualifying infrastructure assets. To bring even more transparency, liquidity, and investment to the infrastructure marketplace, we recommend expanding the types of infrastructure assets that qualify for REITs or developing similarly tax-advantaged Infrastructure Investment Trusts.

There are also situations in which tax rules can affect efficient delivery of infrastructure projects, which Congress could address in a tax reform bill. For example, a municipality that wants to sell or lease to a private partner an infrastructure asset that was originally financed with tax-exempt debt must first “defease,” or repay, any debt that remains outstanding. In other words, the benefit of the municipal tax exemption cannot be passed on to the new, private owner of the asset. Options for defeasance are currently limited and can be costly. More flexibility in these rules would empower the public and private sectors to develop solutions to infrastructure challenges that meet local needs.

These are all direct measures that Congress could take to help meet infrastructure needs. Although not the focus of this post, Congress should also be mindful of the impact that other changes in the tax code could have on infrastructure. For example, if marginal rates are lowered, the value of tax exemptions and tax credits would be reduced, potentially raising borrowing costs for state and local entities that utilize these mechanisms to finance infrastructure and other governmental needs. A comprehensive tax reform bill will undoubtedly have many moving parts, and its overall impact on infrastructure will depend upon the totality of the package, not any single provision.

Congress should also be mindful of the impact that other changes in the tax code could have on infrastructure. 

Of course, there are also other changes needed to federal infrastructure programs outside of the tax code, such as incorporating a life-cycle approach, accelerating the permitting process, and developing a project pipeline. We hope those reforms will be taken up by other committees. Still, the tax reform discussion presents a unique opportunity to finally address long-standing funding challenges and leverage additional private capital for infrastructure. Though crumbling roads and tainted water may not be the primary focus of the tax writing committees, those committees could play a meaningful role in modernizing America’s infrastructure by incorporating infrastructure within comprehensive tax reform.

KEYWORDS: 115TH CONGRESS, HIGHWAY TRUST FUND, INFRASTRUCTURE, JOHN DELANEY, PRESIDENT DONALD TRUMP, TAX REFORM