David Seltzer, Distinguished Practitioner
The National Center for Innovations in Public Finance
University of Southern California
September 25, 2002
Good morning, ladies and gentlemen. My name is David Seltzer, and I am a principal at Mercator Advisors, LLC, a consulting firm that advises public, private and nonprofit organizations on infrastructure financing issues. I also am affiliated with The University of Southern California’s National Center for Innovations in Public Finance. The National Center, established two years ago, undertakes research and helps provide mid-career professional training in the field of infrastructure finance, including the growing use of public-private partnerships for project delivery. I would like to submit for the record a copy of a report USC published last year on California’s 10-year experience with Innovations in Public Finance, which may prove informative to your Committees.
Previously,
I had the privilege of serving as Capital Markets Advisor for three years at
the U.S. Department of Transportation during TEA-21’s authorization, and before
I that spent over 20 years assembling bond issues for transportation and other
public agencies as an investment banker.
So having worked in the public and private sectors, I have clearly
violated both ends of the timeless dictum of “neither a borrower nor a lender
be.”
You
will be hearing testimony this morning from a distinguished array of Federal,
state, local and private sector experts in connection with new financing
initiatives for reauthorization. Since
many of the new ideas draw upon tax incentives as well as other Federal policy
tools, I commend you on making this is a joint hearing of both the tax writing
and surface transportation authorizing committees.
I
found when in Federal service that the wide array of financial tools,
techniques and even terminology can be bewildering. If I may, I’d like to put on my academic hat for a couple of
minutes and try to present an analytic framework that may be helpful in
comparing so-called “Innovative Finance” options.
The
term “innovative finance” in Federal transportation parlance encompasses not
only new financing techniques such as State Infrastructure Banks and TIFIA
credit support, but also new approaches in the areas of project delivery, asset
management, and service operations. In
many cases, the techniques involve some form of public and private sector
partnering. Private participation is
seen as offering the potential to transfer risks, achieve production or
operating efficiencies, and attract additional capital.
In order to systematically analyze the cost- and policy-effectiveness of an innovative finance proposal, I believe it would be useful to employ a “Federal Policy Comparator.” A comparator is a scientific instrument used for measuring the features of different objects. In much the same way, it should be possible to compare various innovative finance proposals within an analytic framework to determine which proposals would be most effective.
The Federal Policy Comparator would seek answers to three central questions:
1. Which Federal Policy Incentives are most suitable to attaining the proposal’s objectives?
2. Does the proposal achieve balance among Sponsors, Investors and Policymakers? And
3. What is the Budgetary Treatment of the proposal?
·
Regulatory Incentives make existing programs and tools more flexible, in
order to expand project resources or accelerate project delivery. (GARVEE Bonds are one such example, in that they
broadened allowable uses for grants to include paying debt service on bond
issues that fund eligible projects.
Other regulatory reforms include design-build contracting, in-kind match
and environmental streamlining.)
·
Tax Incentives involve modifying the Internal Revenue Code to attract investors into
transportation projects. (Examples
include private activity bonds, tax credit bonds, and tax-oriented leasing.)
·
Credit Incentives provide Federal assistance in the form of Federal
loans or loan guarantees to reduce the cost of financing and fill capital
gaps. (Examples include Federal credit
instruments provided through TIFIA and the Railroad Rehabilitation and
Improvement Financing (RRIF) program.)
·
Generally, there is a
tradeoff between the budgetary cost
of the incentive and its degree of
effectiveness in making the desired capital investment feasible. For instance, many regulatory reforms have
little or no budgetary cost, but they also generally provide only very
incremental assistance in advancing projects.
Tax measures typically are a “helpful but not sufficient” pre-condition
for investment; the project must be on the margin of viability to benefit from
them. Credit assistance can fill
funding gaps and attract co-investment, but its uncertain cost depends on risk
factors and interest rate subsidies.
For instance, a complex and capital-intensive initiative such as Maglev
may confer significant mobility, environmental and technology benefits. However, it also may well require deeper tax
and/or credit subsidies in order to bring projects to fruition than that
afforded by an incentive such as private activity bond eligibility.
2.
Does the Proposal Achieve Balance Among Sponsors, Investors and
Policymakers? To be successful, each innovative financing initiative
should be designed to meet the requirements of three distinct groups of
stakeholders. First, the proposal must
be attractive to project sponsors—the
public or private entity responsible for delivering the project. Attractiveness to the project sponsor can be
measured in terms of its cost-effectiveness, flexibility, and ease of
implementation. Second, the proposal
must make sense to investors—offering
them a competitive risk-adjusted rate of return. Capital is notoriously unsentimental, and the innovative finance
tool must compete for investor demand against other investment products in the
marketplace. And finally, the concept
must make sense to Federal policymakers. This entails not only achieving public
policy objectives but also being affordable in terms of budgetary cost. These three groups—project sponsors,
investors and policymakers – can be thought of as the legs of a three-legged
stool. If any one leg of the stool has
shortcomings, the proposal will wobble, and probably not be supportable.
For
example, dating back to the 1993 Federal Infrastructure Investment Commission,
there has been a wide-stated interest in trying to voluntarily attract pension
fund capital into the infrastructure sector.
Public, union and corporate plans represent over $3.6 trillion of
assets, yet they have virtually no U.S. transportation projects in their
portfolios. Why? Because the dominant financing vehicle to
date has been tax-exempt municipal bonds.
While the tax-exempt market will continue to be an absolutely critical
component of infrastructure financing, pension funds, as tax-exempt entities,
place no value on the tax-exemption.
Pension funds gladly would purchase infrastructure debt if it were offered
at higher taxable yields, but that has limited appeal for the project sponsors
who can access the municipal market.
Consequently, the three-legged stool is uneven. (I note that various proposals have been
introduced recently to create a “win-win” security that is both cost-effective
for borrowers and competitively-priced for pension fund lenders—while at the
same time satisfying Federal policy drivers.)
3. Finally, what is the Budgetary Treatment of
the proposal? Efficient markets rely upon transparent pricing
signals to function properly. However,
oftentimes when Federal proposals are being developed, the key pricing
information– budget scoring—is at best translucent, if not completely
opaque. It seems it is the mysterious
scoring of a proposal, and not its policy effectiveness, that too frequently
drives the ultimate policy decision – perhaps a case of the “tail wagging the
dog.” Better information on budgetary
costs earlier on in the process would benefit the development and evaluation of
alternative policy options.
Unlike
corporate and state and local entities, the Federal government makes no
budgetary distinction between current period operating outlays and long-term
capital investments. Nor does it
distinguish between full faith and credit general obligations and limited
special revenue pledges. From the
perspective of infrastructure advocates, this is both inequitable and
inefficient: Inequitable in that costs
are not shared by future beneficiaries, and inefficient in that there is a bias
toward considering those proposals that have the lowest front-end costs, rather
than looking at cost-effectiveness over the long-term.
Some
Federal innovative finance concepts attempt to overcome this problem by drawing
upon either credit reform budgetary rules (a rare case where Federal accounting
is on an accrual basis and conforms to best commercial practices) or by
utilizing the tax code (where the PAYGO rules recognize tax expenditures on an
annual basis).
While
some may consider these tools to be unnecessarily complicated attempts to circumnavigate
cash-based accounting, I believe they offer the benefit of rationalizing the
budgetary treatment of capital spending and facilitating sound decision-making
on Federal infrastructure policy.
In
conclusion, I submit that by using this three-part Federal Policy Comparator as
an analytic framework, policymakers can more systematically compare the
budgetary cost with the policy effectiveness of proposals. It would allow comparisons of initiatives as
varied as private activity bonds for intermodal facilities, shadow tolling for
highways, national or regional loan revolving funds for freight rail, tax
credit bonds for high-speed rail, and reinsurance for long-term vendor
warranties. By way of illustration, I
am including as an attachment a pro-forma Federal Policy Comparator analysis of
four current or proposed Federal innovative finance tools for surface
transportation – GARVEE Bonds, TIFIA Instruments, Private Activity Bonds and
Tax Credit Bonds.
Thank
you very much for your time. I would be
happy to answer any questions you might have.
Attachments
Appendix A. Federal Policy Comparator PowerPoint Slides
Appendix
B:
Findings
& Recommendations: A Roundtable
Discussion of California’s Experience with Innovations in Public Finance,
The National Center for Innovations in Public Finance, University of Southern
California,
April, 2001.
Table 1: Key Drivers on
Innovative Finance Proposals for Project Sponsors, Investors and Federal
Policymakers
Perspective |
Key Questions |
Project
Sponsor / Borrower |
§
What
is the effective financing cost (IRR)? §
How
high is the Annual Payment Factor? §
Is
the transaction reported as a direct or contingent liability on the Sponsor’s
balance sheet? §
What
legal steps (state legislation, etc.) must be taken to utilize it? §
How
difficult is it for Management to implement it? |
Investor |
§
Is
the risk-adjusted rate of return competitive? §
Is
there a secondary market for the product (liquidity)? §
Are
there other investment risks (tax compliance, call risk, etc.)? §
Will
it help diversify the investor’s portfolio exposure? §
Are
there any other strategic reasons for investing aside from its return? |
Federal
Policymaker |
§
What
is the proposal’s budgetary cost? §
Is
the finance tool cost-effective (how much leveraging of Federal resources)? §
What
is the overall economic return (benefit/cost ratio)? §
How
well does it achieve multiple Federal policy objectives? Ø
Improve Access Ø
Enhance
Mobility Ø
Shift Risks away
from the Government Ø
Attract
Non-Federal Resources / Private Participation Ø
Accelerate Projects |