Recently, I was asked what I thought of the $1 trillion infrastructure plan that Trump has repeatedly mentioned in his campaign – and more specifically, my thoughts on the white paper put forth by Wilbur Ross and Peter Navarro. While I had originally looked at their proposal I hadn’t thought about the Ross-Navarro Plan in some time so I went back for a re-visit.
Before we move forward I want to explicitly state at the outset that I am not in favor of Keynesian Spending (Demand-Side Economics). Trump’s infrastructure plan has always been the one part of his platform that I have been uncomfortable with. I am opposed to any government-funded infrastructure stimulation program. As a proponent of free markets and a conservative, I favor reductions in overall government spending and lowering of taxes. Federal expenditures on capital projects simply in order to boost economic growth and employment is a failed policy approach. Any resulting economic stimulus is inherently long-term in nature and should always be done for fundamental needs only. This does not mean I am against any infrastructure spending but I believe infrastructure spending is best done at the state and local level and with as much private participation as possible. Infrastructure spending should be allocated carefully and should not done with the primary goal of achieving economic growth. Federal expenditures used to stimulate economic growth through infrastructure builds could be more efficiently deployed simply by cutting taxes and allowing private companies to grow. Federal spending on infrastructure projects for short-term economic stimulation is akin to taking water out of one end of a pool and pouring it in the other. The only real economic stimulation from such a program is inherently long-term.When approaching infrastructure spending there are some basic tenets to bear in mind:
- Carefully examine and analyze real and fundamental infrastructure needs
- Avoid politically driven expenditure goals at all costs
- Reduce federal government involvement wherever possible
- Push expenditures down to the state and local level whenever and wherever possible – we shall return to this at the end of the analysis
- Privatize where possible
- Utilize private sector financing and participation through Public Private Partnerships (PPPs)
- Reduce and remove regulatory and environmental barriers
- Understand that infrastructure spending produces long-term – not short-term – impacts
Additionally, we should eliminate two specific items:
- Remove Obama’s Project Labor Agreement requiring collective bargaining
- Remove the Davis-Bacon Act requiring above market wages
With those thoughts stated we move on to some general infrastructure information. Here are some data points from McKinsey Global Initiative’s report Infrastructure productivity: How to save $1 trillion a year (contains internal link for full pdf report) and their follow-up piece Bridging Infrastructure Gaps:
“MGI estimates that infrastructure typically has a socioeconomic rate of return of around 20 percent. In other words, one dollar of infrastructure investment can raise GDP by 20 cents in the long run.”
“The world needs to invest about 3.8 percent of GDP, or an average of $3.3 trillion a year, in economic infrastructure just to support expected rates of growth.”
“The world currently invests some $2.5 trillion a year in the transportation, power, water, and telecom systems on which businesses and populations depend.”
“The U.S. spends 2.4% of GDP on infrastructure – 0.7 points below the estimated need.”
“Governments can increase funding streams by raising user charges, capturing property value, or selling existing assets and recycling the proceeds for new infrastructure.”
“Practical steps could boost productivity in the infrastructure sector by as much as 60 percent, thereby lowering spending by 40 percent for an annual saving of $1 trillion.”
Before we continue, I will make one simple, but significant assumption about the plan – that, as a nation, will move forward and invest in our national infrastructure through some means.
By adopting the assumption that the infrastructure investment will be made in one way or another, we have taken one argument against the proposal (one I share) away at the onset – that investing in our national infrastructure is crowding out other investments, using scarce capital and impacting available levels of employment. We live in a finite world with finite resources. Capital – both financial and human – is limited. A $1 trillion infrastructure upgrade is mammoth and will consume a large amount of these resources. As I have and will continue to note, federal spending on infrastructure is a zero sum game in the short-run.
There has long been both public and private sector infrastructure building and investment. Things like natural-gas fired power plants, communication networks, gas pipelines, etc. have long been (and should be) the province of the private sector. Projects such as highways and roads, airports and dams typically fall into the public sector. The reasons for this division primarily have to do with the ability – or inability – to source revenues and profits from these projects. What is different about the Ross-Navarro plan is how it melds the public and private infrastructure elements through leverage and tax credits – bringing together two historically separate arenas of infrastructure development. Public and private partnerships are not entirely new – there have been many examples – known as P3s – but they have been of smaller scale and used for stable and predictable revenue generating ventures such as local toll roads. The Ross-Navarro plan sets itself apart by using leverage and tax credits to attract investors to projects they historically would have avoided due to limited return potential.
The plan in many ways is more of a concept paper and can be found here. The basic assumptions are fairly simple and recognize that equity needs to be levered to produce a return high enough to draw investors. Ross and Navarro use an estimated leverage of five times equity – or $167 equity investment for each $1,000 of project cost. Their interest rate assumption is 4.5%-5% although this may need to be moved slightly higher to adjust for the market’s response to the expected economic growth from a Trump presidency.
In essence, the basic proposal looks no different from a typical project financing deal with two notable exceptions. First, the proposal puts forth a skeleton for project financing without the specific project – those are to be determined by the government going forward. Secondly, the plan incorporates a tax incentive in the form of a tax credit equal to 82% of the equity amount. The plan assumes that the tax credits offered to private investors would be offset by tax revenue from new wages to construction workers and new profits from contractors. This is for incentive purposes – in part because revenue (and profit) from any project funded in this manner is likely to be lower than a more normal project financing deal. The risks to the contractor on these projects are higher as well. The contractor is not bidding on the construction of a power plant run by a utility – in that case the contractor is simply computing construction costs against payments from the utility to determine his return. In the case being put forth by the Trump Administration, the contractor is the investor and he gets his returns from the project he has built.
There are several problems with this:
- Who determines the projects to be undertaken – really a universal problem
- Not all projects produce similar returns
- The amount of tax credit might need to be adjusted depending on the project
- The plan leaves aside any projects that are not inherently revenue producing
- How are the revenues from each project monitored – is a monopoly being created
- This type of funding and tax credit incentive does not fully address foreign contractors
- Inherent conflicts between public and private interests can occur
There are some attractive elements as well:
- Only economically feasible infrastructure projects will be undertaken – no “bridge to nowhere”
- Construction efficiency would be enhanced to increase return on investment – timeliness of completion would increase
- Private investors will be attracted to projects historically shunned
- There will be enhanced returns on public funds through competition
- Maintenance and repair would not be deferred as it impairs the investment
- Ownership of the projects remain public
- Significant transfer of risk from public to private sector occurs
- Project costs would be lower – more infrastructure builds per dollar spent
The Ross-Navarro plan was attacked when it was revealed but most of the complaints were vague in their claims and any specifics tended to focus on the tax credit element. Of particular irony were the linguistic gymnastics employed by folks like NY Times Paul Krugman. These critics have argued for years in favor of massive infrastructure stimulus, yet now denounce a Republican President’s more creative approach to the very policy they have endorsed. The general idea of public-private partnerships being used on a larger scale is a good one and will hopefully be deployed with more frequency going forward.
One credible issue noted by critics of the plan is that the private aspect will not fully address all types of infrastructure spending. Some projects will simply not generate the level of revenue required to attract private funding. I agree with this but see no reason why it hinders the plan itself. My guess is that this proposal, in some formulation, would run parallel to a more conventional infrastructure building program as a result.
Finally, there are real concerns and questions with using the tax credit application. Unlike many critics, I am not opposed to the fundamental idea. I see nothing wrong with enhancing equity returns to the point where they attract investment. It is the practical application of the tax credits I worry over. For example, how does one apply the tax credit to projects of differing risk levels? Theoretically, higher return and/or lower risk projects should require a lower rate of return – and a reduced incentive through a lower tax credit application. How would this be handled – perhaps through a bidding process?
I think the Ross-Navarro idea is a creative approach to public infrastructure on its basic merits. I am in favor of anything that helps introduce a private element to government projects. But, as I noted above, at this stage it is really more of a concept still to be fleshed out. I welcome fresh ideas and approaches to government spending – bringing private investment into the overall process warrants further consideration. Finding new and innovative ways to attract investors to lower revenue, lower return projects that have been traditionally shunned by the private sector is a worthwhile effort and I applaud the non-traditional approach and thinking. In theory, enhancing equity returns through leverage – as a means to attract investors towards projects traditionally rejected – is a good one and deserves more serious consideration and treatment than it has been given.
Therefore, my concern regarding the Ross-Navarro plan has little to do with the plan itself. The primary issue is federal spending as a means to stimulate the economy. As I noted earlier, infrastructure spending does not impact the economy in the short-term. Spending on infrastructure requires money that could be used elsewhere – most preferably to fund tax reductions which are almost immediately stimulative. Federal infrastructure spending is a zero-sum game in the short-term – borrowing from Peter to pay Paul. In the long-term, infrastructure spending does produce benefits but they are difficult to quantify and they are…long-term. So, my concern is not the underlying fundamentals of the Ross-Navarro proposal. My concern is related to any intention to utilize federal spending as a means to stimulate our economy. I am not against infrastructure spending when and where it is needed – good transportation networks are vital to our economy. But federal infrastructure programs generally prove extremely wasteful, inefficient and often target projects driven by political goals rather than economic need. If you doubt this statement then look no further than the billions we have spent on public mass transportation ($9 billion in 2015) that have resulted in little actual benefits.
At the beginning I noted that infrastructure spending is best accomplished at the state and local level. Let’s take an illustrative look at our highway funding system.
As it currently stands now, motorists pay a federal gasoline tax of 18.4 cents per gallon. This tax is funneled into the federal Highway Trust Fund and it is then distributed back to the states in a complex and varying formulaic arrangement. Billions of dollars are siphoned from this fund for use in programs that do nothing to improve our traffic situation. Federal lawmakers pursue personal goals of mass transit and alternative transit measures not endorsed by the states they are intended for. These total amounts average over $13 billion or about 25% of total funding. And the Highway Trust Fund is running a current deficit of $13 billion – despite receiving $62 billion in additional funds from the General Account since 2008. Our federal highway funding system is a disaster.
But there is a better way – one that could serve as a model for all infrastructure spending.
A proposal put before Congress by Utah Senator Mike Lee, the Transportation Empowerment Act, attempts to address some of the structural flaws in our highway spending by refocusing – and limiting – the federal role in transportation and giving much of the planning and power back to the state level. I quote the basics of the plan from the Heritage Foundation:
“Over the course of five years, the federal fuel tax rates would decrease, from 18.3 cents per gallon to 3.7 cents per gallon (gasoline) and from 24.3 cents per gallon to 5.0 cents per gallon (diesel). At the same time, federal programs more appropriately run by states and cities, such as subway, bus, and bicycle programs, would end. Authority and accountability would return to states and localities, giving them incentives to fund projects according to local priorities, not those of Washington.”
“States would have the option—and would need to decide whether to do so—of funding any programs devolved to them. For example, Oregon could continue paving bicycle paths and adding to the streetcar fleet in Portland, while Texas could dedicate money to road resurfacing and bridge repair projects. States would also need to decide whether to increase state fuel taxes by the amount the federal fuel taxes decreased, such that motorists would see no change at the gas pump. Alternatively, they could pursue other revenue-generating mechanisms—user fees or taxes—to meet the level of transportation revenue they deem necessary to carry out their priorities.”
In other words, decisions on how and where to spend money for transportation systems would be made at the state and city level – by those who best understand the transportation needs of their citizens. Of course, this bill faced strong opposition from Congress – something that should embolden those who have backed it – and should be revisited upon Trump’s formal assumption of the presidency.
The Transportation Empowerment Act is one of the single best ideas I have seen in regards to addressing the real needs of roads and highways. It should be adopted and it should be used as a model for all infrastructure spending.
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