Localities will deliver the next wave of transportation investment

Summary:

• Introduction
• How localities pay for transportation infrastructure
• Pain points for local transportation investment
• State and federal policy often restrict local investment opportunities
• Building a new approach from the middle-up
• Improving local fiscal capacity is just the beginning

Introduction

There is a growing consensus that the United States should boost investment in transportation infrastructure, but simply throwing more money at projects overlooks a crucial trend: the United States is moving into an era where more of the agenda setting and funding responsibilities are falling to local governments.

This is a natural evolution. Cities, counties, and regional governments have long had major investment responsibilities within the national transportation system: they maintain the most roadway mileage in the country, they operate most of the country’s transit systems, and they own and operate most sea ports and airports. But local governments are also especially attuned to local needs. Their ability to plan and design infrastructure upgrades in light of their long-term economic development priorities have built support for some of the country’s most ambitious transportation investments in recent memory, from committing over $100 billion in Los Angeles county to flexible bond issuances in Denver and Atlanta.

Yet not every locality starts from a position of strength when planning and paying for transportation improvements.¹ Fiscal conditions are far from ideal in many places, especially in those cities that still have not seen their General Fund revenues return to levels seen before the Great Recession.² Meanwhile, a 2016 national survey of city finance officers found infrastructure needs are a top source of fiscal burden.³ Combined with changing demands to how people travel and how businesses and people purchase goods, many places face deep uncertainties on how to both maintain today’s assets and find resources to make sensible investments for the future.

Simply put, localities want to invest more, but nearly every place could use additional support, including more financial resources and programmatic flexibilities from federal and state governments, to accomplish their goals.

After all, this shift toward bottom-up transportation planning and investment comes at a time where federal and state roles in infrastructure remain up in the air. Although federal transportation spending has increased nominally in recent years, the country is not necessarily able to drive as many infrastructure upgrades due to the rising cost of materials relative to nominal spending increases.⁴ Moreover, the lack of long-term certainty concerning major federal transportation funding sources like the Highway Trust Fund remains an ongoing challenge, and there are questions whether the Trump administration’s strategic vision may support investment in every market (to say nothing of slashes to programs that already support local investment). At the state level, laws often restrict how local governments can raise their own revenues.

Together, the rise in local responsibility to pay for infrastructure leads to two core questions. First, as localities continue to invest more in infrastructure, how can federal and state policymakers create an environment that is relatively easier—or frictionless—for them to do so? And second, when localities struggle to make needed investments, how can federal and state policymakers better support them? As localities step up to address their infrastructure challenges, they must balance multiple programmatic and budgetary priorities, including public safety, education, healthcare, and other needs, which is not always easy or seamless.⁵

This brief provides additional context to begin answering these questions. It explores some of the major financial levers used to pay for transportation at a local level, before highlighting why this particular moment—marked by tremendous local fiscal capacity issues—is ripe to consider a new approach. While many localities are tackling their infrastructure challenges head-on, that does not mean they all have the programmatic flexibility and financial wiggle room to take on even more responsibility, which must be considered as federal and state governments revise their approach to infrastructure investment.

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How localities pay for transportation infrastructure

When devising their spending plans, localities must address a host of transportation needs, given their extensive ownership and operation of many different systems and facilities. Not surprisingly, maintaining and repairing roads represent one of their biggest priorities, with more than 3.2 million miles of locally owned roads stretching across the country.⁶ They also oversee and maintain numerous transit systems, ranging from buses to subways to light rail, which bring their own set of revenue and cost considerations.⁷ Pedestrian and bicycle infrastructure continue to attract greater interest among many localities as well. Finally, most sea ports and airports are locally owned, meaning localities directly support vital interstate commerce via local user fees.⁸

Although the scale and nuance of infrastructure spending can vary widely across the country, localities use the same funding sources to cover their expenditures.

Localities primarily fund transportation investment through a mix of taxes, user fees, and grants. Road, rail, sea, and air facilities all benefit from intergovernmental transfers from federal and state entities.⁹ Yet the majority of funding comes from local fees and taxes, also considered “own-source revenue” or “supporting revenue.” For instance, direct user charges, including vehicle registration fees, parking fees, transit fares, seaport user fees, and airport landing and passenger fees all generate revenue for local transportation systems.¹⁰ Likewise, there are several other general sources, including property taxes, sales taxes, and income taxes, that can help generate additional revenue for transportation. Depending on the specific jurisdiction, however, the flow of revenue from these sources can differ markedly.¹¹

Critically, many of those revenues can help secure another primary source of transportation investment: borrowing. Municipal bonds and other tax-exempt debt offer a low-cost way for localities to finance transportation projects and numerous other types of infrastructure over time.¹² Indeed, the U.S. municipal bond market now stands at about $3.8 trillion, speaking to the enormous breadth of projects supported by localities (and states) issuing debt.¹³ Transportation typically represents around 15 to 20 percent of the market.¹⁴ Although the number of municipal bond issuances fell following the recession—as many localities have struggled to keep up with their existing debt payments, let alone taking on new debt—2016 marked a new high water mark with more than $450 billion in new issuances.¹⁵ Municipal bonds, private-activity bonds (PABs)—which can support a broad range of facilities including airports—and the now-retired Build America Bonds (BABs) are invaluable tools to deliver capital-intensive projects.¹⁶

Using these tools, localities and their state partners have attempted to increase their transportation investment through locally-controlled sources.¹⁷ By going directly to voters, local leaders are able to pass new bonds, approve sales/property tax increases, and activate other revenue streams to pay for a variety of transportation projects; in 2016 alone, 436 transportation ballot measures totaling $250 billion went up for vote, and more than 300 passed.¹⁸ The largest of these include many transit-related projects, 70 percent of which have passed in recent years as shown below.¹⁹ Meanwhile, 26 states have also increased their gas taxes over the past four years, helping to jumpstart additional infrastructure investment on top of these local efforts.²⁰

As a result, state and local transportation construction spending has seen a recent uptick, even in the face of flat lining or falling spending in other infrastructure categories. When adjusted for construction-related inflation, annual state and local spending on road and highway construction is now higher in 2016 than it was prior to the Great Recession.²¹ Spending on other transportation modes—transit, airports, and seaports included—is at a near-record level. These increases are particularly notable given the outsized role many states and localities are playing in operations, maintenance, and capital spending relative to the federal government; they are now responsible for nearly 75 percent of all public spending on transportation each year, while the federal government accounts for only 25 percent.²² This emphasis on transportation spending is also notable when compared to all other state and local construction spending, which is down relative to pre-Great Recession levels, confirming the construction backlog in categories like school construction and water resources.²³Back to top

Pain points for local transportation investment

While localities continue to invest more in transportation, that does not mean it is always an easy or straightforward process. Despite all the financial tools at their disposal and an appetite for greater experimentation, they are still confronting significant budget constraints and other sizable legal and programmatic hurdles to pay for new projects.

Fiscal capacity issues are one of the biggest barriers in this respect. Traditional funding sources, including sales and property taxes, do not provide the same predictable flows of revenue that they did even a decade ago, as people’s consumption habits change and the real estate market grows more volatile in some regions.²⁴ Many localities have also not fully recovered their General Fund revenues from pre-recession levels and face other stiff fiscal headwinds, including rising pension obligations and past debt retirement payments.²⁵ Operational costs are normally the priority of local government, so as long as there are General Fund shortfalls, it’s difficult for localities to commit to expensive capital improvements.

In the face of these declining revenues and rising expenditures, localities are often stretched to their financial limit and must overcome significant spending gaps. Intergovernmental grants from federal and state governments can help bridge these gaps, but such transfers are actually decreasing as a share of local revenue according to the Urban Institute.²⁶ These trends are particularly apparent in highway spending, where intergovernmental transfers have fallen as a share of all local receipts used on highways.²⁷ Tighter local balance sheets also have led to a decline in asset quality beyond highways. While only 2 percent of rural interstates and freeways and 6 percent of urban interstates and freeways are in poor condition—those roads qualifying for federal support—roughly 35 percent of non-interstate roads are in poor condition.²⁸

Of course, individual market conditions matter quite a bit too, where some places lack the stable tax base and economic momentum to drive additional transportation spending. These include older industrial cities in the Rust Belt and beyond, which not only face an urgent need to maintain or outright replace aging transportation assets, but are also contending with slower economic growth and a flat or declining population.²⁹ Rural localities are also grappling with similar challenges, including overall population loss across all rural counties, which can make it difficult to accelerate or attract additional investment.³⁰ In both older industrial cities and rural areas, their deferred maintenance could be even worse due to how long these economic and population trends have been underway.

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State and federal policy often restrict local investment opportunities

At the same time many cities, counties, and regional governments face significant local constraints to invest more in local transportation assets, state and federal policies can also restrict the ability of local governments to pursue new infrastructure investment.

Arguably the most significant restriction is accessing new revenue sources and deploying innovative or alternative financing approaches. In these instances, state preemption often squeezes local fiscal capacity.

Research by the National League of Cities found pervasive restrictions regarding local revenue-raising authority.³¹ Only 28 states allow their localities to levy additional sales taxes to invest infrastructure, including 17 of which require additional local voter approval. Even fewer states approve local-option motor vehicle registration fees (26) and fuel taxes (16). These restrictions extend to cities of various sizes and in states of different political persuasions, from New York City and Charlotte, N.C. to Boise, ID and Cheyenne, Wyo.

Similarly, many states have not passed legislation enabling public-private partnerships, established state infrastructure banks, or developed other transportation revolving funds.³² These statewide programs and tools both provide the opportunity for local public-sector officials to tap innovative financing techniques and for the states themselves to drive investment towards localities. States’ refusal to adopt these policies—plus states where their revolving funds are underused or inactive—is a missed opportunity.³³

Current federal policies also limit local fiscal capacity in certain instances. The surface transportation block grant program ensures a majority of funding funnels directly to localities of various sizes, but it still reserves over $5 billion per year for states’ own control, restricts project types, and even maintains state control over project selection in many cases.³⁴ Most federal transit grants are not permitted to support operations, only capital investments. Federal aviation laws put a ceiling on Passenger Facility Charges—a direct user fee to commercial airline passengers—which limits localities’ ability to bond off future revenues.³⁵

Yet the most concerning aspects of federal policy are what’s to come.

The first issue is the Tax Cuts and Jobs Act of 2017, which was recently signed into law and will take effect in 2018.³⁶ The cap on deductibility of state and local taxes will force many local governments to rethink their approaches to property taxes, general sales taxes, and transportation-specific sales taxes. In some cases, localities will not raise rates out of fear of pushing away residents and businesses. In other cases, localities may respond by lowering tax rates to appear more competitive.³⁷ And all across the country, the drop in corporate and personal income tax rates could reduce demand for purchasing municipal bonds, leading to more expensive borrowing.³⁸ Regardless of exactly how localities and the market respond, the net effect will likely be more expensive financing of infrastructure than under prior federal tax law. And that will cause difficult choices between repaving roads, hiring teachers and police officers, and making long-range capital investments in transportation or other sectors.

Second, proposed changes to existing federal infrastructure programs may not create an even-playing field among localities looking to drive additional investment. The Trump administration is expected to release its long-promised infrastructure concept later this month, but top officials have signaled a three-part investment program that: (1) provides direct funding to rural areas, (2) encourages transformational infrastructure projects, and (3) rewards states and localities that increase net revenues.³⁹ The first program has the potential to help rural areas struggling with population loss and long-term maintenance needs—assuming those funds channel to projects with high levels of use—while the second program’s design and ultimate geographic reach remains largely unknown until more details come out publicly.

The third program, however, could functionally not work for many places. While healthy local economies like Los Angeles, Seattle, and Denver may have more financial capacity to fuel infrastructure investment, what about metro areas struggling to grow their output and/or populations? How can places like Hartford, Conn., Milwaukee, Wis., and Tucson, Ariz. afford to pay more? These kinds of places may not only struggle to compete for limited federal funding, but they may also feel compelled to build projects that may not be designed or prioritized effectively but seem more exciting on paper. Localities in states with preempted revenue-raising authority may also face additional hardship, unable to raise the revenues necessary to compete against their peers.

Finally, the federal proposal could lead to unintended effects within local spending patterns. Introducing new federal grants to states and localities can lead to a substitution effect—meaning governments will find ways to attract federal funding and then shift their spending to other areas, with a net effect of minimal new local spending.⁴⁰ Much like how the new tax law compels accountants to find new ways to reduce their clients’ tax exposure, the federal government should expect local governments to find ways to qualify for new federal grant programs and then shift resources back to other public investment categories. And similar to accountants, local governments will share these techniques with one another.

Of course, there is no guarantee new federal transportation policies would even lead to net increases in federal transportation spending. The Trump administration’s FY2018 budget proposed cuts to many current transportation programs, and the FY2019 budget could do the same. The new tax law will trigger PAYGO rules that force Congress to either waive those rules or cut certain appropriated programs, putting many transportation programs at risk.⁴¹ The only way to be certain net funding will increase is to see how this all looks by the end of 2018.

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Building a new approach from the middle-up

There are certainly reasons to be optimistic about a national transportation investment agenda that operates from a bottom-up vision. Local governments, including local authorities, are closely engaged with the investment needs of their communities and transportation systems. Likewise, their peers in local budgeting agencies understand the capacity of the local economy to afford greater transportation investment—whether via more borrowing or higher user fees—relative to competing needs in education, healthcare, and other public sectors.

State and federal leaders should enact flexible policies that maximize all local governments to invest more in their infrastructure, by not only acknowledging local market conditions but also supporting alternative and innovative financing approaches.

For state governments, that primarily involves eliminating restrictions on local governments’ abilities to tax themselves and attract private investment. States must be willing to let cities, counties, and regional governments experiment with different taxation schemes. If constituents don’t like a local tax regime, they’ll vote with their feet by leaving the region or demanding changes. But states should not preempt localities to even compete for new revenues and the resultant improvements to local transportation infrastructure. States could help build more long-term economic competitiveness by allowing their localities to either increase or authorize access to general-option taxes. Likewise, approving or activating state revolving funds and passing PPP-enabling legislation could help attract new investment.

For the federal government, infrastructure policy is set to be a priority issue in 2018. As the largest category of public ownership within the infrastructure sector, transportation is central to that debate.⁴² Beyond the obvious feature of increasing net investment, new policies should recognize variable fiscal capacities and look to create a platform for greater investment in any place. Rather than reward those who can afford the smallest federal matching rates, the administration and Congress should design a program that uses a sliding scale to support localities concordant with their fiscal capacity and investment need. Infrastructure projects last for generations, meaning poorly-designed policies—especially those that only benefit certain places—could exacerbate divergent economic growth rates already seen across the country.⁴³ The coming months are a critical time to begin designing programs that work for all places.

To this end, federal leaders should not be scared to have an opinion on project types and objectives. In particular, maintenance is universally seen to be the biggest long-run concern for the country—yet a new maintenance project may not have the same political benefits of a fresh ribbon-cutting, nor are our economic models well-equipped to estimate what happens when we remove assets currently being used. Incentivizing maintenance in all markets—especially older, slow-growth places—may deliver the greatest national economic benefit, easing funding shortfalls in some places and freeing up financial creativity in others. Similarly, evolving requirements around asset management plans are a vehicle to incentivize project planning with greater accountability to long-run economic, social, and environmental objectives.⁴⁴

Finally, federal leaders should incentivize states to remove their preemptions. If the current administration believes there is not enough transportation investment, state preemptions are a direct blockade to their vision of all levels of government investing more. While it would likely be legally impossible to circumvent these state laws—effectively, a federal preemption of state preemptions—it’s worth exploring how the bully pulpit could be used to convince states to eliminate restrictions. Similarly, there could be lessons from past techniques like withholding funding as it related to state drinking and seat belt laws.⁴⁵Back to top

Improving local fiscal capacity is just the beginning

Localities would benefit from more durable revenues to invest in their transportation future. The items discussed in this brief are one way to improve their long-run fiscal outlook: continued experimentation with new revenue tools and financing techniques; less restrictions via state law; tailored flexibility within federal policy.

Improving federalist relationships, however, will only address one of the many fiscal-related threats to building competitive and equitable transportation networks. Adoption of electric vehicles will lead to reductions in fuel tax revenues at all levels of government. Shared vehicles and especially autonomous vehicles could upend where people and businesses choose to locate, creating new fiscal winners and losers based on jurisdictional geography. E-commerce, especially in terms of establishment locations and fleet fuel technology, further obscures the future fiscal picture. And with income inequality only growing, how can the nation ensure all people can afford vital transportation services?

Local governments must be ready for an era of great fiscal uncertainty, a time when past will likely not mean precedent. This change in mindset and planning may not come easily or quickly. However, a willingness to throw out old policies, to test new revenue-raising techniques, and to adopt innovative revenue models will all be essential to delivering transportation networks that can support local economic growth for the coming decades.

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