EconSouth - Second Quarter 2008

Courtesy of the State Archives of Florida Work on the U.S. interstate highway system—one of the nation's most ambitious infrastructure projects—began in 1956. Here, work on the Florida Turnpike proceeds in May 1956.

The United States, with its vast network of roads, bridges, and water and sewer systems, has a daunting infrastructure to maintain. In the fast-growing Southeast, the challenge extends beyond meeting today's needs to accommodating tomorrow's growth.

Homeowners never get excited over the prospect of replacing a roof or a hot water heater. Nor do businesses welcome replacing broken-down or obsolete equipment. But regardless of whether they dip into their savings or lean on credit, wise homeowners and businesses figure out a way to make an investment that in the long run beats the alternative of doing nothing.

However, when the job is bigger—specifically, maintaining the physical infrastructure of the United States—the decisions about what to do and how to do it can become almost paralyzing. With massive repair bills piling up in the inbox, the nation's infrastructure payment plan is far from settled.

Paved with good intentions
Americans need look no further than their highways to see a classic example of their problem. When President Eisenhower created the Interstate Highway System in the mid-1950s, the federal government agreed to pay, through the Highway Trust Fund, for 90 percent of new interstate construction and 80 percent of state highway construction. Funds for road maintenance, however, were intended to come from state government. But where are those funds?

Related Links National Council for Public-Private Partnerships Federal Highway Administration information about public-private partnerships American Society of Civil Engineer's report card on the U.S. infrastructure

Taxes were supposed to endow the Highway Trust Fund, which would accumulate states' money for repairs until it was needed. However, deposits into the fund have not been as substantive as projected because the gasoline excise tax per mile of travel, when adjusted for inflation, has fallen by half since the mid-1960s. During the same period, the number of heavy trucks on the road tripled, an unforeseen increase that pushed the highway system's maintenance costs beyond what engineers expected.

Still, with revenues and costs going in opposite directions, the ultimate strain on the nation's infrastructure may be the political economy at the heart of its creation. The funding disparity, combined with the simple fact that new construction is more glamorous and visible to voters, has encouraged state departments of transportation to pursue new road construction even as existing roads reach the end of their usable life, according to the Department of Transportation's Federal Highway Administration.

Struggling to make the grade
A report card on the nation's infrastructure prepared by the American Society of Civil Engineers (ASCE) depicts a nation with a crumbling infrastructure and significant problems funding its repair.

All infrastructure categories drew grades of Cs (mediocre) or Ds (poor), with an overall grade of D. These ratings shouldn't be surprising, considering the nation's $112.9 billion annual spending on infrastructure maintenance and repair falls far short of the $1.6 trillion needed, according to the ASCE, for the projects identified through 2010.

Falling in the C range were solid waste treatment (C+), bridges (C), and rail (C–). Aviation, dams, energy (the items composing the national power grid), disposal of hazardous waste, roads, drinking water, navigable waterways, transit systems, and wastewater received ratings in the D range.

The American Society of Civil Engineers says the condition of U.S. roads merits an overall grade of D, with congestion and poor condition costing motorists billions of dollars annually.

In the ASCE's state-by-state assessment of the biggest problems, roads topped the list in 48 states, including all Southeastern states. Janet Kavinoky, director of transportation infrastructure at the U.S. Chamber of Commerce and the executive director for Americans for Transportation Mobility Coalition, testified before the Senate Environment and Public Works Committee on Feb. 6, 2008, about the state of American roads. Her testimony noted that 36 percent of America's major urban highways are congested with motorists spending 4.2 billion hours a year stuck in traffic.

Annoyance aside, this congestion costs money: Kavinoky cited estimates that wasted time and fuel cost American drivers $78 billion a year. Also, with 33 percent of the nation's major roads in poor or mediocre condition, Kavinoky noted that motorists incur an additional $67 billion—about $600 per driver—in vehicle repairs (because of wear and tear) and operating costs (because of congestion) per year.

For the most part, urban drivers in the Southeast fare even worse, ASCE statistics indicate. Congestion and repairs cost Atlanta motorists $1,065 per year, followed by those in Miami ($927), Orlando ($904), Tampa ($742), and Nashville ($730). Of the region's major metropolitan areas, only Birmingham ($468) and New Orleans ($299) are below the national average.

Kavinoky also said that poorly maintained roads contribute to a third of all highway fatalities—about 14,000 deaths every year—and that the nation's transportation system is "overworked, under-funded, increasingly unsafe, and without a strategic vision."

Quoting the Transportation Research Board's National Cooperative Highway Research Program's study "Future Financing Options to Meet Highway and Transit Needs," Kavinoky noted that the average annual gap in capital, operations, and maintenance funding to maintain the nation's highway and transit systems from 2007 to 2017 totals $50 billion. To improve these systems, the average annual gap is more than $100 billion, she said.

At the same time, the cost of materials used to fix pavement, such as steel, oil, and concrete, has increased 33 percent in the past three years, according to Kavinoky. Yet despite these growing needs and costs, current estimates project the Highway Trust Fund will be $4 billion–$5 billion in the hole in fiscal year 2009. Meanwhile, the user fees on fuels that are the primary source of funds at the federal level have not been increased since 1993.

Southern exposure
Southeastern states have varied infrastructure needs, yet one trait is common to their agendas: There's not enough money to accomplish them.

Alabama. Through 2035, the state's transportation needs, excluding transit, are projected at $57 billion, with revenues projected between $47 billion and $51 billion by Alabama's Department of Transportation. Factoring in transit, the projected needs are $62 billion, with projected revenue between $50 billion and $53 billion.

Florida. Through 2030, the state projects its infrastructure needs at $187 billion, with $129 billion funded through a combination of taxes and tolls, according to the state's budget office (see the sidebar).

Georgia. During the next six years, Georgia's Department of Transportation forecasts a gap of $7.7 billion between its infrastructure needs ($19.2 billion) and projected funding ($11.5 billion). During the next 30 years, these forecasts also show a gap of $74 billion between its infrastructure needs ($160 billion) and projected funding ($86 billion).

Photo courtesy of the Federal Emergency Management Administration In the Southeast as well as the rest of the United States, the condition of bridges is a major concern. Approximately one in five bridges in Florida, Georgia, and Tennessee and three in 10 in Louisiana and Mississippi are considered structurally deficient or functionally obsolete.

Louisiana. The state is currently working on a $14 billion infrastructure backlog, but funding has been identified for only $550 million a year, according to the state's Division of Administration. Most of the revenue is slated to come from gasoline taxes. The division also reported that Louisiana is using a budget surplus from 2007 to provide up to an additional $500 million in 2008 and is implementing a progressive plan that will dedicate revenue from vehicle license fees and the vehicle sales tax. Beginning in 2008, the state will dedicate 10 percent of this revenue to infrastructure and increase the percentage in subsequent years until 2013, when 100 percent of this revenue will be dedicated to infrastructure.

Mississippi. The state's Department of Transportation has published a long-range transportation infrastructure plan that estimated needs of $22 billion between 2003 and 2030, with revenue identified for only $15.1 billion.

Tennessee. The state's long-range plan includes $24 billion in transportation needs over the next 10 years, according to the state's Department of Transportation. Initially, the department's revenue forecasts indicated a $2 billion funding gap, but declining federal revenues and the sharp increases in project costs have changed the department's projections to a $5.5 billion gap, with potential for it to grow wider.

U.S. bridges—and more—fall short
But physical infrastructure needs extend beyond asphalt. The second-biggest infrastructure concern in the Southeast, as well as the nation, is bridges, with 17 states (including Alabama, Mississippi, and Tennessee) identifying bridge repairs as their No. 2 priority. Approximately one in five bridges in Florida, Georgia, and Tennessee is considered structurally deficient or functionally obsolete, according to the ASCE. In Louisiana and Mississippi, the figure is approximately three in 10.

Despite these widespread problems, the Southeast has been spared a bridge disaster since 1993, when barge collisions were responsible for two different incidents. Two people were injured and one was killed when a barge struck the Claiborne Avenue Bridge in New Orleans, and 103 were injured and 47 killed when a barge hit the CSXT Big Bayou Canot rail bridge near Mobile, Ala. The Southeast's last bridge disaster caused by neglect was in 1989, when deterioration of foundation timber led to the collapse of the Hatchie River Bridge 45 miles north of Memphis, killing eight.

The ASCE identifies wastewater issues as a top need in both Georgia ($2.3 billion) and Louisiana ($2.4 billion). Louisiana's tab could have been higher if the city of New Iberia hadn't just constructed a new $30 million wastewater plant in response to Clean Water Act violations in 2005, city officials confirmed.

The lone area in which the Southeast appears to be faring better than the rest of the nation is drinking water. Seven states outside the region identified drinking water as one of their top needs in the ASCE report card, and their maintenance price tag for drinking water is estimated between $280 billion and $400 billion. But the maintenance total cited in the report for the six Southeastern states is only $10 billion.

The ABCs of PPPs
One source of funds to restore or build existing infrastructure is a public-private partnership (PPP). Typically, such an agreement between a government entity (local or state) and a private enterprise involves granting a franchise to a private firm to operate and, in some cases, build a piece of municipal or state infrastructure. Recent examples of PPP agreements include the Chicago Skyway and the Indiana Toll Road.

In the Southeast, the Mississippi state legislature is considering a PPP for a toll road from Gulfport, Miss., to Memphis, Tenn. The state or local government sets the tolls, and the private firm, which builds the road, uses the toll revenue to recoup its investment and earn a profit.

A local or state government pursuing a PPP effectively signs one of two types of contracts as it sells or leases its infrastructure. For instance, the government can specify an allowed rate schedule or tolls (in the case of roads)—which are typically anchored to a measure of inflation or economic growth—and then allow firms to bid on the right to own or lease the franchise for a given period. This type of contract was employed in the recent 75-year lease of the Indiana Toll Road for $3.8 billion to a Spanish-Australian consortium.

Alternatively, a PPP can negotiate a contract with a fixed rate of return, often referred to as a "cost-plus" contract. If the state pursues an allowed rate schedule, it risks negotiating a bad deal up front and then watching as a firm reaps excessive profits that could have been captured by the state. Conversely, the firm also bears any losses. One potential drawback of a cost-plus contract is supplying a firm with an incentive to inflate costs to generate a higher profit (a practice sometimes referred to as "gold plating").

In either case, the power of market competition occurs only when the contract is put out for bid, and even then the number of eligible bidders may be small given the enormous required capital and necessary technical expertise. Once agreements are reached, the firm and the local government must work together for the next 20 to 100 years, depending on the length of the contract. Over time, officials in the government who regulate private operators run the risk of becoming beholden to the firms they ostensibly manage, a dilemma known as "regulatory capture."

A PPP, like any marriage, can go sour. In 1999 Atlanta contracted with United Water to run its water system for 20 years at a fixed price. However, the deal was abandoned in 2003 as water users complained about poor service and water quality, and United Water lost money trying to manage the antiquated pipes and facilities in the infrastructure.

To PPP or not to PPP?
Despite these potential drawbacks, several arguments favor using PPPs to meet infrastructure needs. First, state and local governments may not have sufficient funds or bonding capacity to build roads themselves. PPPs offer the promise of uniting cash-strapped state and local governments with vast pools of private money attracted by the steady, predictable returns promised by infrastructure.

Advocates for PPPs also contend that private firms can operate public infrastructure more efficiently than local governments either because of greater experience from operating multiple franchises around the world, including automated electronic tolling technology, or because private firms, obliged to shareholders, will have a strong incentive to hold down operating costs.

Perhaps the most compelling case for private ownership, though, is that raising tolls is politically difficult for elected officials. A private entity would be more insulated from political pressure and could more easily increase tolls to meet maintenance and improvement needs.

However, arguments can be made that PPPs aren't really necessary. For example, cities and states could fund a project directly by issuing their own tax-favored debt (statutory debt ceilings notwithstanding). Also, although government may have a difficult time managing its workforce given the temptations of patronage, managing a private firm poses its own challenges. Local governments must negotiate very complex, long-term contracts with firms that will usually have much more experience with such deals. In the recent 99-year lease of Chicago's Skyway toll road, for example, the city paid Goldman Sachs $20 million in advising fees.

Finally, the claim that states are unwilling to raise tolls is not universally true. Elected officials essentially commit to raise rates when they enter into a PPP; for Indiana's Toll Road, officials raised rates before the sale to command a higher sale price.

PPPs afford the opportunity to raise rates on future users that cannot be readily reversed by subsequent elected officials. Of course, politicians could also do this by issuing bonds backed by tolls or fees, but such fees are typically limited to paying off 30-year bonds. By raising tolls and fees themselves, states could turn public infrastructure into profit centers.

Public need versus popularity
In the end, taxpayers and policymakers must confront some basic limitations of the market and of the local political economy. Roads, pipes, and sewers are natural monopolies that can, in many cases, command substantial economic rents. Governments must decide to either regulate them or own them outright. Elected officials, with one eye on the election calendar, may choose the high profile of new construction at the expense of long-term maintenance of existing works. But this same tendency may also lead them to sell off valuable assets at fire-sale prices. On the other hand, given the huge backlog of deferred maintenance and great uncertainty about future needs, the chance to share capital and risks with private investors may be too appealing to resist.

For the Southeast as well as the United States, local and state governments are confronting the vast majority of infrastructure challenges. Rehabilitating America's infrastructure will not depend on a single choice but on a multitude of decisions. Only time will tell who made the right ones.

This article was written by Ed English, a staff writer for EconSouth, with Chris Cunningham, a research economist and assistant policy adviser at the Atlanta Fed.