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NEWS

Federal Impediments to P3 Market Growth

27 May 2016, Posted in All Posts, Blog Posts

By Shane Skelton, Executive Director

The U.S. Public Private Partnership (P3) market is beginning to gain steam. As we pointed out in our Policy Brief, “Innovation in the P3 Marketplace,” states and localities across the country are becoming more creative in the types of infrastructure projects P3s are being used to fund and the different financing mechanisms being employed on these projects. On the other hand, the federal government has not traditionally pursued P3 project financing. However, as U.S. infrastructure falls further into disrepair and the federal government dives further into debt, P3s could emerge as a commonsense solution to the country’s infrastructure funding challenges.

The federal government has taken modest steps to signal it understands the value of, and opportunities provided by, P3s over the past year. While this is a positive sign, structural barriers to capturing the full benefits of P3s remain. The following is a short summary of what the federal government is doing to facilitate the use of P3s for major infrastructure projects and how federal budget scoring rules may hinder future progress.

Law Firm Squire Patton Boggs and Practical Law Finance recently published a comprehensive P3 Market Update, which detailed recent federal government initiatives to promote P3s:Extended Transportation Infrastructure Finance and Innovation Act (TIFIA) authorization and credit assistance funding through fiscal year 2020. The provision also allowed states to use National Highway Performance Program and Surface Transportation Program funds to pay the subsidy and administrative costs for projects receiving TIFIA assistance.

-Established a competitive discretionary grant program for large projects on the National Highway Freight Network, highway or bridge projects on the National Highway System, intermodal projects on the National Multimodal Freight Network, or rail-highway grade crossing and separation projects.

-Reauthorized the Capital Investment Grants program – a roughly $2 billion annual competitive grant program that funds rail, streetcar and bus rapid transit projects – and created a pilot program to incentivize private funding.

-Created a pilot program – aimed at increasing innovation, improving efficiency and timeliness of project implementation and encouraging new revenue streams – allowing the Secretary of Transportation to enter into up to eight Full Funding Grant Agreements to expedite the delivery of new fixed guideway, Small Starts, or Core Capacity public transportation projects undertaken as P3s. The federal share of project costs under this pilot program is limited to 25%.

-Established a new Finance Bureau that will administer numerous transportation infrastructure funding and grant programs and make highway and surface freight transfer facility private activity bond allocations. The Bureau will submit a report within one year one year evaluating the application processes for the programs the Bureau administers, identifying administrative and legislative actions that would improve the efficiency of the application processes without diminishing federal oversight, and describing how the Executive Director will implement the administrative actions identified that do not require legislation. The Bureau will:

-Work with the USDOT’s modal administrations, eligible entities, and other public and private interests to develop and promote:

–Best practices with respect to standardized state P3 authorities and practices, including those related to accurate and reliable assumptions for analyzing P3 procurements, procedures for the handling of unsolicited bids, policies with respect to non-compete clauses, and other significant terms

–Standard contracts for the most common types of P3s for transportation facilities; and

–Analytical tools and other techniques to aid eligible entities in determining the appropriate project delivery model, including a value for money analysis.

–Ensure transparency of P3 projects receiving credit assistance under the programs it administers by:

-Requiring the sponsor to undergo a value for money analysis or comparable analysis prior to deciding to advance the project as a P3;

-Requiring the value for money analysis and other key terms of the P3 agreement to be made publicly available by the project sponsor at an appropriate time;

-Requiring the sponsor to conduct a review regarding whether the private partner is meeting the terms of the P3 agreement within three years of completion of the project; and

-Providing a publicly available summary of the total level of federal assistance in such project.

-Develop procurement benchmarks, including:

–Establishing maximum thresholds for acceptable project cost increases and delays in project delivery;

–Establishing uniform methods for states to measure cost and delivery changes over the life cycle of a project;

–Tailor benchmarks, as necessary, to various types of project procurements, including design-bid-build, design-build, and P3s.

-Transformed the Surface Transportation Program into a block grant program and makes grant funds newly available for:

–A state’s creation and operation of a P3 office to assist in the design, implementation, and oversight of P3s eligible to receive federal funding under title 23 and chapter 53 of title 49;

–Payment of a stipend to unsuccessful private bidders
 to offset their proposal development costs, if necessary to encourage robust competition in P3 procurements.

–Created the Regional Infrastructure Accelerator Demonstration
 Program and authorized $12 million for the Secretary to establish one or more regional entities to develop financing strategies and otherwise promote and accelerate the development of projects eligible for TIFIA assistance.

–Removed a provision in Water Infrastructure Finance and Innovation Act (WIFIA) that prohibited water infrastructure projects from being funded with a combination WIFIA assistance and tax-exempt bonds. The new law allows WIFIA eligible projects to use of low interest WIFIA loans to cover 49% of project costs and tax-exempt bonds for the remaining 51%, facilitating expanded use of P3s in the water infrastructure space.

There are also barriers to greater federal participation in the P3 market. One of the primary barriers to passing pro-P3 legislation is how federal budget scoring rules portray the costs of P3 programs and projects, and how those costs trigger anti-spending rules or anti-spending sentiment. The Brookings Institute has published extensively on the topic.

In a Brookings Institute discussion paper titled “Time for a New Budget Concepts Commission,” scholars Barry Anderson and Rudy Penner articulate a number of obstacles current budget scoring rules pose to federal investment vehicles. Scoring (or lack thereof) of Macroeconomic Impacts and Capital Investments stood out to me as particularly noteworthy:

Macroeconomic Impacts. Recently, congressional rules have been amended to require an analysis of the macroeconomic impacts of major tax and spending proposals (e.g., “dynamic scoring”). A new Commission might consider the methods that should be used and how the results might be displayed in the budget.

Macroeconomic scoring of government expenditures differs from the more traditional practice of static scoring in that it looks at how the particular spending would impact the economy as a whole to determine its net impact on the budget. For example, if the federal government authorized ten million dollars per year of spending on upgrading ports, harbors, and inland waterways, static scoring would show that as a $100 million expenditure over the ten year scoring window without capturing any benefits.  A macroeconomic or “dynamic” analysis would reflect the increased revenue to the government resulting from the increased economic activity resulting from commerce attributable to the cargo that can now make it to our shores and travel throughout the country.

Capital Investments. It is obvious that capital investments by the government have a very different impact on the economy than do current expenditures. Assuming that the investments are well allocated, they add to productivity growth and improvements in living standards in the long-run. Current expenditures may have immediate benefits but little effect on the long run. Therefore, many advocate that the budget should treat capital outlays differently from current expenditures. A presidential commission considered this topic several years ago and recommended against having a formal capital budget because of the problem of defining “capital” and the worry that the definition of capital would expand rapidly if it were deemed permissible to deficit finance “capital” spending. A new Commission on Budget Concepts should revisit this important topic and decide whether it agrees with the previous capital budgeting commission.

In a separate piece, “Reforming Federal Property Procurement: The Case for Sensible Scoring,” Dorothy Robin highlights how budget scoring rules, and particularly OMB Circular A11, increase government’s real property acquisition costs, and leads to wasteful and expensive leases in the place of public infrastructure investments.

[The Office of Management and Budget (OMB) and the Congressional Budget Office (CBO)] defend the A­11 scoring rules on two grounds. One is cost: lease­purchases and public­private ventures are forms of third­party financing, and it is invariably more expensive for the federal government to use third­party financing than to purchase a capital asset directly. That is so because even the best private interest rates exceed the rate at which the U.S. Treasury can borrow. The other justification for A­11 is transparency: like an installment plan, lease­ purchases and public­private ventures “hide” the government’s real long­term cost commitment, leading to suboptimal decision­making in the annual budget process.

The scorekeepers’ cost argument is narrowly correct—it is less expensive for the federal government to buy a building (or a building renovation) directly than to finance it privately. But their premise that federal agencies could cover the large, single­year funding spikes that such purchases require has proved false over a 23­year period of unrelenting budget pressure. The result has been a textbook example of unintended consequences: lacking the budgetary resources to meet genuine facility requirements, federal agencies have resorted to practices more costly—and no more transparent—than the ones A­11 was designed to combat.

One such practice is reliance on short­term operating leases to meet long­term federal facility requirements. Since 1990, GSA’s inventory of federally owned space has increased only slightly, while its leased inventory has doubled in size (measured by the number of square feet). Leasing is generally more expensive than ownership, as the scorekeepers recognized, and short­term leases are more expensive than long­term leases because they increases the lessor’s risk. GSA leases typically have only a 10­year term (a longer lease runs the risk of getting scored as a capital lease), even though GSA’s federal tenants stay in their leases for much longer—27 years on average. GSA Administrator Dan Tangherlini recently told Congress that it cost the federal government twice as much to lease as to buy or build a facility.

Consider the new (2008) Department of Transportation (DOT) headquarters, which GSA sited on the Anacostia River in Southeast DC in part to spur development there. GSA leases the 1.35 million square foot building, which was designed with DOT in mind, for $45 million a year under a 15­year operating lease (a 20­year lease would have been scored as a capital lease). Under A­ 11, GSA was not allowed to negotiate a lease that would have given the government ownership of the building at the end of, say, 25 years or that would have included a major discount on the building’s end­of­lease market price (another arrangement that is common in the private sector). Thus, at the end of 15 years, having spent some $675 million for a building that cost far less than that (around $400 million) to build and having no equity to show for it, GSA will have to extend the operating lease or re­compete the requirement. Even if the owner is willing to sell GSA the building at that point, the price will be far higher than the equivalent 2008 price because of all the federally anchored development that has occurred around it.

The current scoring system is rigged to prioritize short-term fiscal restraint over sound long-term investments. The irony is that the United States’ long-term debt and general solvency aren’t dependent in any way on how much spending is authorized in a given year, but rather whether every dollar that leaves the Treasury is heavily scrutinized and allocated to yield maximum return either through long-term savings or to improve efficiency in dispensation of government services.

All told, the federal government is working towards recognizing the potential value of private investment in public or shared infrastructure. Wrinkles remain, and change comes slowly at the federal level, but progress should be applauded. P3s have an exciting future in the U.S. and all of our countries infrastructure will benefit.