Is it the End of Pay-as-You-Go in Transportation Finance?

Reed, James B.

The federal government is offering states some new ways to fund transportation projects that may help get needed ventures off the ground.

It's easy to be cynical about transportation systems. Building and repairing highways, transit facilities, airports and railroads seem to take forever and cost too much. Most of us can remember more than once being stuck in traffic or in a crowded train station and mumbling to ourselves "Why don't they do something about this?" In many places, the answer is: They can't afford it.

State governments are the "they" most responsible for much of America's transportation infrastructure. In 1998, states collected and spent more than $81 billion ($37 billion from federal aid) just for highway construction, maintenance and administration. They spent billions more upgrading public transit, developing airport facilities, maintaining rail systems and funding local transportation projects.

Historically, states have funded transportation projects on a 'pay-as-you go' basis, paying for construction, maintenance and administration as money became available from user fees and federal grants. States have also financed projects by assuming debt that could be paid back by state funds. Now, despite healthy economies, existing revenues may not be enough. In many states, legislatures can't solve transportation problems because they can't afford to. Rapid growth has increased public demand for transportation services, strained existing infrastructure and drained financial resources. Some states are projecting budget shortfalls in the tens of billions of dollars for transportation.

"There is a tremendous demand for transportation services," says Max Inman, chief of the Federal Highway Administration's (FHWA) Financial Management Division. "There are significantly underfunded programs and maintenance needs beyond our available funding capacity. Costs are going up, and we will need to do more," he says.

In response to these growing concerns, state policymakers are rethinking the old ways. With federal cooperation, some states are exploring "innovative financing" for future transportation needs. "Revenues are not keeping pace with growing demand," says Suzanne Sale, FHWA senior financial adviser. "Transportation officials are looking for new approaches that allow them to use scarce funds more effectively."

The Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA) and the Transportation Equity Act for the 21st Century (TEA-21), passed in 1998, encourage new state finance programs and offer federal assistance to carry them out. Several of these techniques are gaining acceptance in the states.

SPENDING YOUR CHICKENS BEFORE THEY'RE HATCHED

Grant anticipation revenue vehicles (GARVEEs) allow states to issue bonds secured with the pledge of future federal aid funds. Prior to TEA-21, states were prohibited from repaying their debt with federal money. TEA-21 removes this hurdle by guaranteeing federal funding levels through FY 2003 and includes an equity provision that ensures that each state will get back a share of the Highway Trust Fund equal to 90.5 percent of its percentage contribution.

The new approach is good for states, says Ron Marino, an investment banker with Smith Barney in New York. "Being able to leverage federal dollars gives states more options."

Several states, including Colorado, New Mexico, Ohio, Mississippi, New Jersey, Arkansas and Massachusetts, have already taken advantage of GARVEEs to finance major construction projects.

Colorado Senate President Ray Powers says the GARVEE measure that passed in his state last year was the key to adding lanes to congested I-25 and an $874 million extension to Denver's light rail system, "This gets us the money earlier so we can build projects as we need them, rather than waiting for the money," says Powers. "We need to construct highways right now, and this will make it cheaper."

States can tailor GARVEEs to meet specific needs. Different GARVEE structures give states options for repaying bonds, allowing states to use future federal funds for bond repayment or as repayment insurance. New Mexico will help pay for an expansion of State Route 44 from two to four lanes with $100.2 million in GARVEE bonds, guaranteeing the entire amount with future federal grant money.

Massachusetts sold $921.7 million in GARVEE bonds for the "Big Dig" project in Boston to help pay for the reconstruction of part of Interstate 93 as a tunnel. The state will pay off the bonds with a mixture of federal aid and state gas tax money.

Ohio raised $90 million from GARVEE bonds to construct Interstate 670 and State Route 315 and improve traffic flow in downtown Columbus. The bonds are primarily backed by future federal grant money. However, the state structured the bonds so that several different revenue sources can be used to pay them back if future federal money is not enough. Lawmakers also made a "moral obligation" pledge to use state gas tax revenue and general appropriations in the event of a federal shortfall.

GARVEEs are not just useful for highway and road construction. Last year, the New Jersey Transit Corporation issued $151.5 million in GARVEE bonds to purchase 500 new buses. The bonds--sold in March 1999--were the first transit debt issued under TEA-21 and are backed solely by a pledge of future Federal Transit Administration (FTA) funding.

WHEN A LITTLE HELP IS ALL THAT'S NEEDED

One part of TEA-21, the Transportation Infrastructure Finance and Innovation Act (TIFIA), helps states pay for large projects that have some funding, but need additional loan money for completion. Under the act, the federal government gives states credit assistance, rather than grants. They can get a direct loan or the feds can guarantee a loan or provide a standby line of credit.

This year, the U.S. Department of Transportation can support up to $1.6 billion in state loans under the program. An additional $9 billion in credit assistance is available through FY 2003.

Last September, the department gave out the first awards: $1.3 billion for the Miami Intermodal Center, $749 million for the Farley-Pennsylvania Station in New York City, $397 million for the State Route 125 project in San Diego, $1.7 billion for the Tren Urbano rapid transit line in San Juan, Puerto Rico, and $2.3 billion for the Washington Metro Capital Program. The Federal Railroad Administration should issue rules for a similar railroad infrastructure improvement program this year.

GETTING SEED MONEY TO BLOOM

The State Infrastructure Banks (SIBs) are a promising innovative financing tool that now faces declining support from Congress.

Established by the 1995 National Highway System Designation Act, these banks use seed money from the federal or state government to get started and offer customers a range of loans and credit enhancement. State and local government agencies borrow money from SIBs to finance transportation projects.

The program is particularly effective for smaller projects. "Local agencies like it because it's cheap money, a simple application process, you don't have to pay lawyers, low rates, and you don't have to go to the bond market," says Kris Wisniewski, the SIB coordinator for Michigan.

The problem in Michigan and in other states is lack of funding. Congress authorized 38 states and Puerto Rico to develop these banks in 1995 and 1996. In TEA-21, however, Congress prohibited all but four states from using federal money to support their SIBs. Although the original 39 jurisdictions are authorized to continue the programs, only California, Florida, Missouri and Rhode Island can finance their banks with federal transportation funds authorized through FY 2003.

This move stripped financial support from many of the state infrastructure banks. Now, state legislatures may need to fill the gap for them to succeed.

"We can't use federal money for it at this point," says Wisniewski. "Although we have support at the state level, we never promoted ourselves to the Legislature for funding, and we are running out of money. We need to resolve the issue of financing so the program can sustain itself permanently."

TWO THINGS AT ONCE SAVES TIME AND MONEY

Traditionally, a transportation project was first designed and then built under a separate bid. Now, under time and money saving design-build programs in 20 states and the District of Columbia, a single team submits a plan based on technical factors and price. Since one team performs the design and construction, construction can start before all design details are finished.

Design-build contracting is being used for the 1-15 project in Utah. The state began expanding this major north-south arterial in Salt Lake City to eight lanes in 1997. The project adds two lanes along 16.5 miles of highway and will include HOV lanes in each direction. Using the design-build approach, Utah will be able to complete the project in four and a half years, saving an estimated three years of time under traditional contracting methods while keeping costs well in line with previous estimates.

"If we had it to do over, we would do it exactly the same way," says Joe Walker, supervisor of public information at the Utah Department of Transportation.

"When we first looked at the project," Walker adds, "we were looking at an eight- to nine-year period. But when we got the Olympics in Salt Lake City, the feeling was that we needed to speed up the process. Design-build absolutely saved time. When we finished the design portion of the project, we were already at the halfway point in construction. Under normal methods, we would have been just breaking ground."

TEA-21 allows states to use federal aid funds for design-build contracts after receiving FHWA approval. Projects have been approved in Alabama, Alaska, Arizona, California, Colorado, District of Columbia, Florida, Indiana, Hawaii, Maine, Maryland, Michigan, Minnesota, New Jersey, New York, North Carolina, Ohio, Oregon, Pennsylvania, South Carolina and Utah.

GETTING A HAND FROM BUSINESS PARTNERS

More than a dozen states allow agreements with highway construction contractors, engineering consulting firms, toll facilities, private developers and the financial community to pay for transportation construction and operations. Sometimes it works, sometimes it doesn't.

One success story is California: State Route 91, a 10-mile toll road that connects Anaheim and Riverside County. The $126 million project is the first completed under California legislation passed in 1991. The California Private Transportation Company has a 35-year franchise agreement with the state to operate the four-lane highway. The company broke even with more than $20 million in revenues in 1998. The California Highway Patrol enforces traffic laws on the toll road, and the state transportation department takes care of maintenance. Both agencies are paid from toll revenues. An interesting aspect of SR 91's operation is time-of-day road pricing. Tolls are set based on congestion and number of people in a car, thereby ensuring a congestion-free ride for those who pay the $.75 to $3.50 toll.

In Virginia, a public-private partnership for a toll road from Dulles International Airport has been a disappointment. The Dulles Green-way--touted as the model for constructing public facilities with private funds--failed to meet expectations. Planners hoped the 14-mile, four-lane highway from Dulles International Airport to Leesburg would attract thousands of commuters from fast growing Loudon County and raise some $40 million a year by 1998. But it didn't happen. The project was completed late and over budget. After the road opened in 1995, travel and revenues were much lower than expected. The private owners missed their scheduled debt payments and defaulted for three years on the original bonds used to fund construction. Recently, they've sold more than $300 million in bonds to try to rescue the project.

TAKING THE TOLL OUT OF TOLL ROADS

Tolls are a growing source of money for highways. There are toll roads in 29 states, and they are bringing in more than $4 billion a year. Typically, tolls pay for maintenance as well as debt service on bonds for the initial construction.

Tolls and similar sources of "new" transportation revenue are not likely to become the panacea for financing shortfalls. They aren't always popular with the public, and since all roads can't be toll roads, it is at best a limited source of new revenue.

Toll financing is popular for some roads, however, because it is a precise way of linking benefit to user costs. Only those using the road pay for it. Though it is sometimes called double taxation--since motorists pay state and federal gasoline taxes at the pump--it's not. Tolls cover only the cost of the particular project. In addition, drivers on the "free" roads enjoy less congestion, as some cars move to adjacent toll roads.

Three factors may make toll financing standard practice in the years ahead. First, the need to preserve and rehabilitate existing roads will grow large enough to take all available public funds, leaving little or none for new road construction. Second, electronic variable pricing systems can be raised during peak times to limit the number of vehicles, thereby ensuring free flowing traffic. Third, advances in technology will make toll collection invisible. Motorists of the future will be scanned as they pass toll booths and receive a monthly bill.

A pilot program established in TEA-21 allows toll collection on existing interstate highways, bridges or tunnels to pay for reconstruction projects. In addition, pilot states can turn high occupancy vehicle (HOV) lanes into HOT lanes (high occupancy toll), charging single occupant vehicles a fee to use them. These HOT lanes, also known as "Lexus lanes," are a way to get more bang from underused HOV lanes and reduce congestion on "free" roads. States setting up HOT lanes must develop an analysis of the potential impacts on low-income drivers.

LEGISLATURES TAKE LEADING ROLE

State legislatures are key to many of the new innovative financing ideas. Legislative authorization is required for innovative financing such as GARVEEs, design-build contracting and public-private partnerships. State lawmakers also can provide the funding needed to support SIB programs. "Legislators need a good understanding of what's available," says FHWA's Inman. "It's not simple. You can't just build a bridge any way you want to build a bridge."

It is easy to write off innovative finance proposals as merely new ways to increase state debt. The new financing, however, promises to help states afford current transportation needs.

So is the era of pay-as-you go over? Probably not, say many experts. "Grant financing is still the predominant way to go," says Inman. "This is not replacing pay-as-you-go. However, many projects, particularly big item projects, need some sort of debt mechanism to help supplement the funding. The advantage collectively is to build things quicker at lower costs and to give states and local governments a variety of different options. By building early, the state can save money and get the facility into the community earlier."

Mat Sundeen tracks transportation finance issues for NCSL. James B. Reed directs the NCSL Transportation Program.

WHAT BIG PROJECTS NEED FINANCING?

The federal highway department says there are 31 large transportation projects that need a total capital investment of $50 billion to complete. Here's sampling:

PROJECTS PROJECTED COSTS
* Dalton Highway project in Alaska $165 million
* Hoover Bridge construction in Arizona and Nevada $120 million
* California high speed rail $16.8 billion
* Florida Overland Express $5.3 billion
* U.S. 82 Mississippi River Bridge $166 million
* Shreveport to Kansas City High Priority Corridor $2.38 billion
* Miami Intermodal Center $1.7 billion
* South-North Light Rail Transit Project in Portland, Ore. $1.3 billion

AVIATION FUNDING TAKES OFF

States and airport operators are breathing easier now that Congress and the president agreed in March to a new, three-year, $40 billion reauthorization of the Federal Aviation Administration and the Airport Improvement Program. The legislation frees $1.9 billion this year in grants for airport infrastructure upgrades, technological improvements, noise mitigation and safety compliance. Funding, which comes from the Airport and Airway Trust Fund, increases significantly to $3.4 billion in FY 2003.

Disagreements between the House and Senate over taking the trust fund off-budget stalled reauthorization. States and airport operators have been without grant funds since Sept. 30, 1999, and numerous projects have been delayed. The budget impasse was resolved by an agreement to use parliamentary points of order to ensure that authorized levels of spending are actually appropriated, rather than taking the trust fund off-budget.

Though the lapse in funding was a significant problem for states, they are not without their own resources. States invest about $450 million annually in planning, operations, infrastructure development, maintenance and navigational aids at more than 5,000 airports across the country.

CITIZEN TAX REVOLT KILLS TRANSPORTATION FUNDING

Washington state faces a particularly difficult situation for transportation project money after a voter initiative went into effect in January.

Voters passed a popular antitax measure-Initiative 695-last November. It eliminates the state's excise tax on cars, replacing it with an annual $30 license fee. Some citizens had paid as much as $1,200 per vehicle.

The move slashed $750 million a year from state revenues, as well as $2.4 billion in major road construction projects that were approved in the 1998 election. The state department of transportation lost a third of its budget under the measure, and many local governments lost money needed to pay for police and transit operations.

The Legislature is struggling to make up this loss in the coming fiscal year and devise a long-range plan to replace the lost revenues.

DO NEW LANES MEAN MORE TRAFFIC?

If you build them, will they come? States faced with congested roads often send in construction crews to add new lanes. In theory, bigger highways should unclog traffic and reduce travel times.

But some engineers and researchers argue that those new miles of lanes will draw new traffic, in a phenomenon the call "induced travel." It occurs when motorists take advantage of new lanes to take more or longer trips or to switch from transit to driving. New development along newly widened roads also generates new traffic, adding to congestion.

New research finds that from a quarter to a half of new highway lanes are filled up with induced traffic. A study using 26 years of data from Maryland, Virginia and North Carolina found that drivers who hadn't been suing the road before, used up a third of the new lanes on major highways. For Maryland, induced travel took up 45 percent of new capacity. In Virginia it was 51 percent. Another study, focusing on 15 year of data from major American metropolitan areas, found a 28 percent induced travel effect. Both studies concluded that population growth and increasing wealth were the leading causes of induced travel.

Environmentalists and some urban planners contend that induced travel reduces the benefit of new roads, worsens congestion, promotes sprawl and wastes transportation money that could be invested in transit or other alternatives. In booming Colorado, opponents of a $700 million expansion of I-25 argue that induced traffic will clog new lanes. By the year 2020, they projected that the wider highway will save drivers only a minute off their existing commutes.

Others doubt the induced traffic phenomenon exists. Many road builders and highway engineers contend that greater numbers of people, more women in the workforce and the economic boom are all much bigger factors. They question whether induced travel is a big cause of congestion and argue that new and better roads are essential for economic development.