Congressional Budget Office
Director's Blog

The nation’s transportation and water infrastructure—its highways, airports, water supply systems, wastewater treatment plants, and other facilities—plays a vital role in the economy. Private commercial activities and the daily lives of individuals depend on that physical infrastructure, which is provided by all levels of government in the United States. In fiscal year 2007—the most recent year for which data on combined spending by the federal government and by state and local governments are available—total public spending for transportation and water infrastructure was $356 billion, or 2.4 percent of the nation’s economic output.

Concerns about the nation’s infrastructure have prompted calls for greater spending. The Congress is considering the funding level for the next several years for federal infrastructure programs, such as highways, mass transit, and aviation. In response to a request from the Senate Finance Committee, CBO prepared a study that analyzes recent developments in spending on transportation and water infrastructure, trends in spending for capital and for operations and maintenance, and the rationale for public spending on infrastructure. This study updates a previous report CBO published in August 2007, Trends in Public Spending on Transportation and Water Infrastructure, 1956 to 2004.

Recent Developments in Public Spending for Transportation and Water Infrastructure

Between 2003 and 2007, real (inflation-adjusted) public spending on transportation and water infrastructure declined by $23 billion, or 6 percent. That decline, which reflects a decrease in real capital spending, especially by the federal government, stands in contrast to the fairly steady increase in spending for such infrastructure during the previous two decades. The drop was primarily the result of a sharp increase in prices for materials used to build such infrastructure—an increase that outpaced the growth of nominal (current-dollar) spending on water and transportation infrastructure.

In 2009, the federal government spent $87 billion on transportation and water infrastructure, $6 billion more than it spent in 2007. Of those outlays, about $4 billion was made available through the American Recovery and Reinvestment Act of 2009 (ARRA). In total, lawmakers appropriated $62 billion for transportation and water infrastructure under that legislation. CBO expects that, in nominal terms, federal spending for transportation and water infrastructure under ARRA will total $54 billion through 2013, by which time almost 90 percent of the funds made available for infrastructure through ARRA will have been spent.

The Composition of Public Spending for Transportation and Water Infrastructure

State and local governments account for about 75 percent of total public spending on transportation and water infrastructure—excluding the share of their spending financed by grants and loan subsidies provided by the federal government—and the federal government accounts for the other 25 percent. That split has remained roughly constant for several decades.

In recent years, not quite half of total public funding for transportation and water infrastructure in the United States has been devoted to capital spending for activities such as construction and equipment purchases. State and local governments have accounted for about 60 percent of those capital expenditures, and the federal government has accounted for 40 percent.

A little more than half of total public spending for such infrastructure has been used for operation and maintenance, of which state and local governments have provided about 90 percent. Although the federal government has played a limited role in such funding overall, it has provided much of the resources for operating and maintaining the nation’s air traffic control system.

Spending on highways at all levels of government accounted for 43 percent of expenditures for transportation and water infrastructure in 2007. Expenditures on water supply and wastewater treatment systems accounted for 28 percent of spending; aviation, mass transit and rail made up 23 percent; and the remaining categories of water transportation and water resources accounted for 5 percent.

The Role of Government in Funding Transportation and Water Infrastructure

In the United States, the public sector rather than the private sector typically provides funding for transportation and water infrastructure. Whether it is more efficient for the federal government to provide that funding depends on the type of infrastructure and the likelihood that such infrastructure will be undersupplied if its provision is left to state and local governments or to the private sector.

Evidence suggests that spending for carefully selected infrastructure projects can contribute to long-term economic growth by increasing the nation’s capital stock and raising productivity. Realizing the potential gains depends crucially on identifying projects with benefits to society that will outweigh their costs, but identifying such projects is difficult. The federal government could make its current funding more effective by ensuring that the costs of infrastructure projects are borne by different levels of government on the basis of where the benefits are expected to accrue.

This study was prepared by Nathan Musick of CBO’s Microeconomic Studies Division.

I testified this morning before the Joint Economic Committee about policies to increase economic growth and employment in 2010 and 2011. This hearing was originally scheduled for several weeks ago but then canceled because of the snow. My prepared remarks today were essentially the same as those released a few weeks ago and were based on CBO’s January report on this topic and a follow-up letter to Senator Casey.

My comments emphasized three points:

First, although the economy is starting to recover from the most severe recession since the 1930s, CBO and most private forecasters expect a slow rebound in output and employment. In particular, CBO projects that the unemployment rate will average slightly above 10 percent in the first half of this year, fall below 8 percent only in 2012, and return to near its long-run sustainable level of 5 percent only in 2014. As a result, more of the pain of unemployment from this downturn lies ahead of us than behind us.

Second, fiscal policy actions, if properly designed, would promote economic growth and increase employment in 2010 and 2011. However, despite the potential economic benefits in the short run, such actions would add to the already large projected budget deficits. Unless offsetting actions were taken to reverse the accumulation of additional government debt, future incomes would tend to be lower than they otherwise would have been.

Third, different policies that have received public attention would have quite different effects on output and employment per dollar of lost tax revenue or additional government spending. To be sure, significant uncertainty attends any quantitative estimates of the effects of particular policies, and CBO has emphasized that uncertainty by reporting ranges of estimates that we believe encompass most economists’ views about the effects of each type of policy. Still, we think there would be significant differences in the cost-effectiveness of different policies (as measured in our analysis by years of full-time-equivalent employment per million dollars of total budgetary cost).

Policies that would have the largest effects on output and employment in 2010 and 2011 per dollar of budgetary cost would be those that could be implemented relatively quickly or targeted toward people whose consumption tends to be restricted by their income—for example, reducing payroll taxes for firms that increase payroll or boosting aid to the unemployed. The following figure summarizes the estimated effects of various policies on employment in 2010 and 2011.

Cumulative Effects of Policy Options on Employment in 2010 and 2011,
Range of Low to High Estimates

I was scheduled to testify a few days ago before the Joint Economic Committee about policies to increase economic growth and employment in 2010 and 2011. The hearing was canceled because of the snow, but we released my prepared remarks today. The testimony was based on CBO’s January report on Policies for Increasing Economic Growth and Employment in 2010 and 2011 and on CBO’s follow-up letter last week to Senator Casey, which provided additional information about options for reducing employers’ payroll taxes.

The testimony emphasizes three points:

First, although the economy is starting to recover from the most severe recession since the 1930s, CBO and most private forecasters expect a slow rebound in output and employment. Often, severe economic downturns sow the seeds of robust recoveries. During a slump in economic activity, consumers defer purchases, especially for housing and durable goods, and businesses postpone capital spending and try to cut inventories. Once demand in the economy picks up, spending by consumers and businesses can accelerate rapidly—which in turn generates demand for workers. CBO expects that the current recovery will be spurred by that dynamic, but in all likelihood the recovery will also be dampened by a number of factors. Those factors include the continuing fragility of some financial markets and institutions; declining support from fiscal and monetary policy; and limited increases in households’ spending because of slow income growth, lost wealth, and a large number of vacant houses.

Therefore, as shown in the following figure, CBO projects that the unemployment rate will average slightly above 10 percent in the first half of this year, fall below 8 percent only in 2012, and return to its long-run sustainable level of 5 percent only in 2014. As a result, more of the pain of unemployment from this downturn lies ahead of us than behind us.

Unemployment Rate (Percent)

Second, fiscal policy actions, if properly designed, would promote economic growth and increase employment in 2010 and 2011. However, despite the potential economic benefits in the short run, such actions would add to the already large projected budget deficits. Unless offsetting actions were taken to reverse the accumulation of additional government debt, future incomes would tend to be lower than they otherwise would have been.

Third, different policies that have received public attention would have quite different effects on output and employment per dollar of lost tax revenue or additional government spending. To be sure, significant uncertainty attends any quantitative estimates of the effects of particular policies, and CBO has emphasized that uncertainty by reporting ranges of estimates. Still, significant differences can be seen in the following figure, which shows the cumulative effect of a variety of different policy options on employment in 2010 and 2011, measured in years of full-time-equivalent employment per million dollars of total budgetary cost.

The largest effects on employment this year and next would probably arise from increasing aid to the unemployed, reducing employers’ payroll taxes in general, and reducing employers’ payroll taxes for firms that increase their payroll. Somewhat smaller effects would probably be produced by reducing employees’ payroll taxes, providing an additional one-time Social Security payment, allowing full or partial expensing of investment costs, investing in infrastructure, providing aid to states for purposes other than infrastructure, and providing additional refundable tax credits for lower- and middle-income households in 2011. Still smaller effects would probably be generated by extending higher exemption amounts for the AMT in 2010 or reducing income taxes in 2011.

Cumulative Effects of Policy Options on Employment in 2010 and 2011,
Range of Low to High Estimates

Much of CBO’s extensive analysis and writing on this topic in the past few months has been done by Janet Holtzblatt, Mark Lasky, Ben Page, and Susan Yang.

The public and private sectors in the United States together spend over $500 billion a year on infrastructure projects, including highways and airports, water and energy utilities, dams, waste disposal sites and other environmental facilities, schools, and hospitals. The federal government makes a significant contribution to that investment through its direct expenditures and the subsidies it provides indirectly through the tax system, which are sometimes referred to as tax expenditures. Today CBO and the Joint Committee on Taxation (JCT) released a study on the importance of tax preferences, the types of tax-preferred bonds used in financing infrastructure, and the economic efficiency of such bonds.

That study concludes that the amount that the federal government forgoes through tax-exempt bond financing is greater than the associated reduction in borrowing costs for state and local governments. Some analysts have estimated the magnitude of that differential and conclude that several billion dollars each year may simply accrue to bondholders in higher income-tax brackets without providing any cost savings to borrowers.

The Importance of Tax Preferences in Financing Infrastructure

Most federal tax expenditures for infrastructure are the result of tax preferences granted for bonds that state and local governments issue to finance capital spending on infrastructure. Those tax preferences reduce borrowing costs. The amount of tax-preferred debt issued to finance new infrastructure projects undertaken by the public and private sectors totaled $1.7 trillion from 1991 to 2007. About three-quarters of those bond proceeds, or roughly $1.3 trillion, was for capital spending on infrastructure by states and localities, and the remainder was used to fund private capital investment for projects that serve a public purpose, such as schools and hospitals. That $1.3 trillion amounted to over one-half of the $2.3 trillion in capital spending on infrastructure by state and local governments (that is, net of federal grants and loan subsidies).

Tax preferences for debt are attractive to states and localities because they generally allow those governments to exercise broad discretion over the types of projects they finance and the amount of debt they issue. But unlike direct expenditures, tax expenditures—including tax preferences for state and local bonds—are not subject to the annual appropriation process that determines federal outlays for infrastructure and other discretionary programs. As a result, the cost of tax subsidies for infrastructure is not readily apparent, making the design of cost-effective tax preferences all the more important. For fiscal years 2008 to 2012, federal revenues forgone through the tax-exemot bond financing of infrastructure—both for new investments and for the financing of existing debt—are estimated to exceed $26 billion annually.

The Types of Tax-Preferred Bonds and Their Characteristics

The Internal Revenue Code provides for three forms of tax-preferred state and local bonds:

• Tax-exempt bonds pay interest to the bondholder that is not subject to federal income tax.  They are the most well established type of tax-preferred debt (tax exemption dates to the beginning of the federal income tax in 1913) and are issued to finance either the general functions of state and local governments or selected projects undertaken by the private sector. Tax-exempt bonds reduce the issuer’s borrowing costs because purchasers of such debt are willing to accept a lower rate of interest than that of taxable debt of comparable risk and maturity.
• Tax-credit bonds, by contrast, generally provide a credit against the bondholder’s overall federal income tax liability. They are much more recent in origin, and the outstanding amount of tax-credit bonds currently is minuscule in comparison with that of tax-exempt bonds.
• Direct-pay tax-credit bonds, in effect, require the federal government to make cash payments to the issuer of the bond in an amount equal to a portion of each of the interest payments the issuer makes to the bondholder. Such bonds, which were created by the American Recovery and Reinvestment Act of 2009 (ARRA, Public Law 111- 5), in part because the direct payment to the issuer represents a “deeper” subsidy to the issuer than the provision of a tax credit represents to the bondholder.

Increasing the Economic Efficiency of Tax-Preferred Bond Financing

Replacing tax-exempt interest with tax credits could, in principle, increase the efficiency of financing infrastructure with tax-preferred debt. Tax-credit bonds transfer to issuers all of the federal revenues forgone through the tax preference; in addition, the amount of the tax credit can be varied across types of infrastructure projects, thus bringing the federal revenue loss in line with the benefits expected from the investment.

Nevertheless, tax-credit bond programs have not been particularly well received by the market for a number of reasons, including the limited size and temporary nature of tax-credit bond programs and the absence of rules for stripping and selling credits. That situation is likely to change, however, as a result of the ARRA, which greatly expanded the size and range of tax-credit bond programs. As those new programs are implemented, it will be possible to gauge more accurately the practical advantages and disadvantages of tax-credit bonds.

This study was prepared by Nathan Musick of CBO’s Microeconomic Studies Division and the staff of JCT.

Last week CBO’s Deputy Director Robert Sunshine testified about the financing of the federal government’s aviation programs (basically operations of the Federal Aviation Administration) before the House Ways and Means Committee. Reauthorization of the aviation programs raises a number of significant policy questions:

• How much do we need to spend on those activities, especially to ensure that we have a safe, efficient, and effective air traffic control system?
• How much of those costs should be borne directly by users of the system, and how much by the general public?
• Of those costs borne by users, how should they be allocated among different types of users—or among users at differing times or differing places?

How much to spend. Before the current economic downturn, congestion and delays in the U.S. had risen to record levels.  According to the FAA, in 2007 and 2008 about ¼ of all commercial flights in this country arrived at their destination at least 15 minutes after the scheduled time.  In 2007, about 680 million passengers boarded nearly 10 million domestic revenue flights.  That’s 26 percent more flights than in the year 2000, for about 14 percent more passengers.  Both of those figures have declined somewhat from their peak, but demand for travel is likely to increase again when the economy starts to recover, hopefully later this year. 

The system is clearly under stress, and implementing the next generation air traffic control system will require a significant investment of resources by both the government and the private sector over many years.  CBO has not done any analysis regarding the potential costs of that system, but it seems likely that at least several hundred million dollars a year will be needed for that purpose.

Who should bear those costs?  Most of the benefits of federal aviation programs accrue to users of the aviation system—though the general public also benefits from the use of the system by the military and other government agencies, and from the flow of commerce that the system facilitates.  Historically, a combination of general taxpayers and users of the system have paid for its costs—the users through a set of aviation taxes that flow through the Airport and Airway Trust Fund.  Economists generally believe that a good way to foster efficient use of any system is to charge users for the cost they impose on that system.  In recent years, receipts to the trust fund have covered more than 3/4 of the cost of the government’s aviation programs. 

How should costs be allocated?  It is important to determine not only how much users should pay, but also how to apportion those costs among the various users.  Almost 70% of the trust fund revenues come from the passenger taxes.  Another 20% comes from the international arrival and departure tax.  Fuel and cargo taxes account for the rest.  It’s not clear, however, that this system of taxes encourages efficient use of the system. 

Most of the taxes are linked closely to the number of passengers and the fares they pay—not to the number of aircraft operations.  But the cost of the air traffic control system and the amount of congestion in the system is driven largely by the number, timing, and location of aircraft operations.  For example, over the past several years, the number of aircraft departures has grown much more rapidly than the number of passengers—because air carriers have tended to substitute higher frequency service with smaller aircraft for less frequent service with larger aircraft. 

Finding a way to allocate costs that accurately reflects the impact that various kinds of users have on the aviation system is a real analytical and political challenge, but a better alignment of taxes with costs could help reduce congestion and delays.

As I discussed yesterday, I participated in two panels at the Milken Institute’s Global Conference in Los Angeles on Monday.  The second panel was about “Infrastructure Projects as Economic Stimulus.” You can view the slides and webcast.

My main observations at this second panel were:

• Some of the infrastructure spending in the stimulus package would pass a cost-benefit test even apart from the recession.  For example, CBO’s analysis of infrastructure investment last year concluded that “additional spending of up to tens of billions of dollars each year on transportation infrastructure projects” could be justified as having benefits that exceed the costs.  We warned that economic returns on specific projects vary widely, so specific investments should be selected carefully.  In addition, we explained that some of the additional spending could be avoided by creating incentives to use existing infrastructure more efficiently—such as congestion pricing, which we analyzed more fully earlier this year.  Still, additional targeted infrastructure investment could be appropriate even in normal times. Moreover, these are not normal times, and it may be appropriate to undertake more immediate infrastructure spending than otherwise in order to put idle resources to use.

• CBO projected that infrastructure spending approved in the stimulus legislation would generate outlays—and thus economic stimulus—only gradually.  For example, we are looking for increases in federal highway spending to be 10 percent of the amount appropriated in the rest of fiscal year 2009, 25 percent in FY 2010, 20 percent in FY 2011, and a declining share thereafter.  Although the sluggishness of this projected spend-out surprised some observers, we explained that the need to draft plans, solicit bids, enter into contracts, and then to undertake the work (during appropriate weather) had led previous increases in budgetary resources for highways to be followed by increases in                                      

            Budgetary Resources and Outlays for Highways 

Source: Congressional Budget Office

outlays with a measurable lag. Lags in other areas of infrastructure spending can be even longer, especially where programs are new or receive significant boosts in funding relative to recent years—descriptions that fit provisions in the stimulus package focused on weatherization and broadband expansion among others.  CBO projects that total infrastructure outlays resulting from the stimulus package will peak in 2010 and 2011 but will remain significant for a number of years.  

Infrastructure Outlays as a Result of the American Recovery and Reinvestment Act



Source: Congressional Budget Office

• Very early data on the use of funds approved in the stimulus package are consistent with this perspective.  For example, the Department of Transportation has reported that $7 billion has been obligated for highway spending but only a few million federal dollars have been spent.

This morning I’m testifying before the Senate Finance Committee on infrastructure investment. My statement can be found here, and the webcast is posted here.

The testimony occurs at a time when burgeoning congestion on the nation’s transportation networks and concerns that the nation is underinvesting in its physical infrastructure have focused attention on the federal government’s role in sustaining that infrastructure.

The testimony defines “infrastructure” as including transportation, utilities, and some other public facilities. The nation currently invests more than $400 billion per year in infrastructure defined this way, and about $60 billion of that amount is funded by the federal government each year, primarily for highways and other transportation networks.

The testimony makes the following key points:

• Estimates from the Federal Highway Administration (FHWA) and other sources indicate that additional spending of up to tens of billions of dollars each year on transportation infrastructure projects could be justified. Some of that spending would simply maintain the current performance of existing infrastructure; other projects would improve performance to the extent that the economic benefits
  exceeded the costs (although some projects would have net benefits that were smaller than those that could be obtained from spending on items besides infrastructure).
• Although the rationale for some additional spending is probably strong, the economic returns on specific projects vary widely. Accordingly, even if the Congress were to increase spending, it would be important to identify which projects provided the largest potential benefit from limited budgetary resources.
• Some of the demand for additional spending on infrastructure could be met by providing incentives to use existing infrastructure more efficiently and by devoting current budgetary resources to their highest valued uses. For example, the Department of Transportation has reported that the demand for new spending on highways could be reduced by as much as $20 billion annually if congestion pricing were implemented to encourage efficient use of existing infrastructure.
• A special-purpose entity, such as a federally chartered infrastructure bank, could provide funding for infrastructure outside of the annual appropriation process but would not be a source of “free money”: Any reduction in the federal shares of project costs (obtained by reducing grant sizes or by shifting from grants to loans or loan guarantees with smaller subsidy costs) would require greater shares to be borne by project users, state or local taxpayers, or both.

In addition, attentive readers will note that in what I believe to be a first for CBO, the testimony includes a few lines of poetry (see footnote 47). These lines appear in response to a comment from David Brooks of the New York Times at a public forum that CBO reports don’t have enough “romance” in them; when I asked him what he possibly meant by that comment, he suggested that CBO documents could include some poetry. Footnote 47 was the best we could do for now.

I am testifying this morning before a joint hearing of the House Committee on the Budget and the Committee on Transportation and Infrastructure. To view the hearing click here.

The testimony defines “infrastructure” as including transportation, utilities, and some other public facilities. The United States currently invests more than $400 billion per year in infrastructure defined this way, and about $60 billion of that amount—mostly for highways and other transportation networks—is financed by the federal government each year.

The testimony makes the following key points, among others:

• Growing delays in air travel and surface transportation, bottlenecks in transmitting electricity, and inadequate school facilities all suggest that some targeted additional infrastructure spending could be economically justifiable.
• Federal spending on infrastructure is dominated by transportation. Although capital spending on transportation infrastructure already exceeds $100 billion annually, studies from the Federal Highway Administration, the Federal Aviation Administration, and elsewhere suggest that it would cost roughly $20 billion more per year to keep transportation services at current levels. Those studies also suggest that substantially more than $20 billion in additional capital spending per year on transportation — and perhaps as much as $80 billion per year or so — would be justified on economic grounds if well targeted (because such spending would generate benefits whose value would exceed its cost).
• In some other types of infrastructure outside transportation, such as systems for wasterwater and drinking water, additional spending is needed to maintain current services or allow modest improvements.
• Although the economic rationale for some additional infrastructure spending is strong, the economic returns on specific projects vary widely. Carefully ranking and funding projects to implement those with the highest net benefits would yield a disproportionate share of the total possible benefits at a fraction of the total spending that is potentially economically justifiable. A related point is that the aggregate estimates do not justify increases of those amounts in infrastructure spending unless such spending is carefully targeted to economically efficient projects. Otherwise, the spending would not generate the same benefits as the estimates suggest—and indeed it could produce costs that exceed the benefits.
• The estimates of infrastructure spending that are needed to maintain current performance or that could generate larger economic benefits than costs, furthermore, can be substantially affected by how existing infrastructure is priced.
  • The estimates for highways, for example, assume no expansion in the use of congestion pricing—that is, tolls that are higher during peak times and lower during off-peak times.
  • The Federal Highway Administration, though, estimates that widespread implementation of congestion pricing would reduce the investment needed to maintain the highway system by $20 billion annually.
• Studies suggesting the need for or benefits of additional infrastructure spending do not provide policy guidance about how such spending should be financed. The “benefits principle” suggests that federal taxpayers are often the least efficient source of financial support for an infrastructure investment — after the direct beneficiaries of the investment and local or state taxpayers. Even when federal support for a given type of infrastructure is justified in principle, implementation problems might make it undesirable in practice. The GAO, for example, found that states offset roughly half of the increases in federal highway grants between 1982 and 2002 by reducing their own spending, and that the rate of substitution increased during the 1980s.
• Although many advocates of additional federal infrastructure spending seem interested in complex and sometimes opaque structures through which to channel such federal support, the fundamental question is how much support the federal government will provide and the efficiency with which such support is provided. On the latter point, the federal government could substantially increase the efficiency with which it subsidizes debt financing of state and local spending.
  • For example, state and local tax-exempt bonds will cost the federal government an average of $31.2 billion per year between 2007 and 2011. Yet in 2006 and 2007, observed yield spreads suggest that any bonds purchased by taxpayers in a marginal tax bracket above 21 percent cost the federal government more in forgone tax revenues than they save state and local governments in reduced interest cost.
  • A more efficient approach could involve tax-credit bonds, which allow bond purchasers to receive credits against federal income tax liability (rather than excluding interest payments from federal income taxation).
  • To illustrate, assume that the inefficiency associated with current tax-exempt financing is between 10 percent and 20 percent, so that 80 percent to 90 percent of the federal tax expenditures actually translates into lower borrowing costs for states and localities. Then, if the outstanding stock of tax-exempt debt during the 2007–2011 period instead took the form of tax-credit bonds designed to deliver the same amount of federal subsidy, the federal government would save between $3 billion and $6 billion per year.
• The federal government can also encourage the use of “asset management” to maximize the benefit from existing and future infrastructure. Asset management relies on monitoring the condition of equipment and the performance of systems and analyzing the discounted costs of different investment and maintenance strategies.
  • As one example, the federal government reduce total investment and operating costs by changing the way it acquires, manages, and disposes of property — a topic explored in a box in the testimony.
• The testimony also discusses capital budgeting, a topic that is the subject of a separate report being published by CBO today. A short summary is available here.