Using tax credits to raise US$1 trillion to replace US Interstate Highways and bridges
 The
big turnaround project confronting the Donald Trump
Administration is the US$1 trillion infrastructure spending
programme that stands to energise Middle America.
The US President's troubles with repealing and replacing
the Affordable Care Act, otherwise known as Obamacare,
has proven problematical just as his plans to reform
tax code have stalled.
While there is much to dispute in health care and
tax reform, there is little or no argument about the
need to replace America's infrastructure, its crumbling
highways and bridges, its antiquated air traffic control
system among many other things.
What's more, this is politically useful to a Republican
administration. Just as the vast dredging of America's
ports and harbours was helpful to predominantly Democratic
coastal regions, the Interstate Highways system covers
the "flyover states" between New York and
LA where Republicans are more numerous.
Perhaps that's why Democratic regimes of the Obama
and Clinton years were reluctant to spend on shovel-ready
projects, preferring to finance further studies of what
should be done and in what order. As time went on the
US ended up ninth place in global rankings in roads
investment and 12th in the Global Competitiveness Index
in infrastructure generally.
More than 60,000 American bridges were considered
“structurally deficient”. Traffic delays cost the
US economy more than $50 billion annually. Typical iPhones
were smarter than many of the country's air traffic
control systems.
Beyond inconvenience and expense, the condition of
these bridges now pose mortal dangers. Ten years ago,
111 vehicles crossing the I-35W bridge over the Mississippi
River in Minneapolis plunged into the river 60 feet
below, killing 13 and injuring 145. In 2013, a bridge
on the I-5 north of Seattle collapsed, injuring three
people, when a truck crashed into it. In 2015, a chunk
of concrete fell from the bottom of the I-495 overpass
in Maryland, crushing a car.
What needs to be fixed in what is officially known
as the "Dwight D Eisenhower National System of
Interstate and Defense Highways" (commonly known
as the Interstate Highway System, Interstate Freeways,
or simply the Interstate) is a network of controlled-access
highways that form a part of the National Highway System
of the United States.
Eisenhower, the commanding general of Allied Forces
against the Nazis and later president of the United
States, set it up in 1956. As a junior army officer,
Eisenhower had had travelled in a military convoy from
Washington, DC to San Francisco and was dismayed by
what he saw. Later, during World War II, he encountered
Germany's far superior Autobahn.
As president, Eisenhower made infrastructure spending
a priority. In 1956, he signed a law that established
the interstate highways that still traverse the United
States. Eisenhower saw infrastructure as both an economic
and a national security priority.
There had been talk of federal spending on roads
from the early 19th century, but it was thought to be
constitutionally impossible. But as a dimension of national
defence spending, it became a federal responsibility,
hence its official name.
Eisenhower's highways were part of a series of great
infrastructure projects that helped usher in unprecedented
prosperity. Government investment and private entrepreneurship
laid railways across the continent; built huge power
plants, such as the Hoover Dam; and provided universal
telephone coverage. Those projects generated economic
growth and went some distance to unite the American
republic.
But they required public investment, and in recent
years, that has been lacking. Building new infrastructure
is a critical part of any growth strategy. Every $200
billion in additional infrastructure expenditures is
reckoned to create $88 billion more in wages for average
Americans and increase real GDP by more than a percentage
point. Each GDP point creates 1.2 million additional
jobs.
Pre-Trump Democratic administrations doubled US debt
from $10 trillion to almost $20 trillion. Yet despite
this massive deficit spending, less and less was spent
on infrastructure.
It is plain, and widely accepted that the US has
under-invested in its infrastructure. The federal gas
tax is the main source of federal funding for roads,
bridges, and subways. But Washington has not increased
that tax of 18.4 cents per gallon since 1993.
In real terms, its value has thus fallen by more
than 40 per cent. Expert groups such as the American
Society of Civil Engineers, business associations such
as the US Chamber of Commerce, and unions such as the
AFL-CIO have all called for trillions of dollars of
new investment. But Washington has failed to act.
The Road Taken, a book by Henry Petroski, a professor
of civil engineering and history at Duke University,
helps explain why Washington has been unable to solve
this problem. In part a history of infrastructure, in
part an appeal for greater investment, Dr Petroski's
book offers a rare engineer's perspective on a debate
too often dominated by economists and politicians. Yet
engineers can do only so much on their own. A healthy
national infrastructure requires not just competent
engineers but also a government - and a publican - willing
to pay for it.
The Trump infrastructure plan features a major private
sector, revenue neutral option to help finance a significant
share of the nation’s infrastructure needs, according
to Wilbur Ross, a private equity investor, and Peter
Navarro, business professor of the University of California
at Irvine. Both were senior policy advisors to the Trump
presidential campaign.
"For infrastructure construction to be financeable
privately it needs a revenue stream from which to pay
operating costs, the interest and principal on the debt,
and the dividends on the equity. The difficulty with
forecasting that revenue stream arises from trying to
determine what the pricing, utilisation rates, and operating
costs will be over the decades." said in their
paper entitled "Trump Versus Clinton on Infrastructure".
Therefore, an equity cushion to absorb such risk
is required by lenders. The size of the required equity
cushion will of course vary with the riskiness of the
project.
However, we are assuming that, on average, prudent
leverage will be about five times equity, said the Ross-Navarro
paper. Therefore, financing a trillion dollars of infrastructure
would necessitate an equity investment of $167 billion,
obviously a daunting sum.
"We also assume that the interest rate in today’s
markets will be 4.5 per cent to five per cent with constant
total monthly payments of principal and interest over
a 20- to 30-year period. The equity will require a payment
stream equivalent to as much as a nine per cent to 10
per cent rate of return over the same time periods,"
they said.
To encourage investors to commit such large amounts,
and to reduce the cost of the financing, government
would provide a tax credit equal to 82 per cent of the
equity amount. This would lower the cost of financing
the project by 18 per cent to 20 per cent for two reasons.
"First, the tax credit reduces the total amount
of investor financing by 13.7 per cent, that is, by
82 per cent of 16.7 per cent," they said. "The
elegance of the tax credit is that the full amount of
the equity investment remains as a cushion beneath the
debt, but from the investor point of view, 82 per cent
of the commitment has been returned. This means that
the investor will not require a rate of return on the
tax credited capital."
Equity is the most expensive part of the financing;
it requires twice as high a return as the debt portion,
nine to 10 per cent as compared to 4.5 to five per cent.
Therefore, the 13 per cent effective reduction in the
amount of financing actually reduces the total cost
of financing by 18 to 20 per cent. By effectively reducing
the equity component through the tax credit, this similarly
reduces the revenues needed to service the financing
and thereby improves the project’s feasibility, said
Ross and Navarro.
"These tax credits offered by the government
would be repaid from the incremental tax revenues that
result from project construction in a design that results
in revenue neutrality," they said.
Two identifiable revenue streams for repayment are
critical here: the tax revenues from additional wage
income, and the tax revenues from additional contractor
profits.
"For example, labour's compensation from the
projects will be at least 44 per cent. At a 28 per cent
tax rate, this would yield 12.32 per cent of the project
cost in new revenues. Second, assuming contractors earn
a fairly typical 10 per cent average profit margin,
this would yield 1.5 per cent more in new tax revenues
based on the Trump business tax rate of 15 per cent,"
they said.
Combining these two revenue streams does indeed make
it appear that the Trump plan is fully revenue neutral
with 13.82 per cent of project cost recovered via income
taxes versus 13.7 per cent in tax credits.
Trump’s core concept of tax relief to facilitate
project investment is not especially new. It has been
used historically to target real estate investment.
However, the concept of offsetting a major portion of
project cost with income tax credits that are repaid
as issued by means of the tax revenues generated just
by the construction is new. Because the combination
is revenue neutral, whatever taxes flow from the actual
operation of the new infrastructure will be additive
to tax revenues.
In the end the big job using this and other methods
will get done because American is good for it.
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