In this assignment, we will be ‘playing the role’ of financial analyst in the Kentucky Finance and Administration Cabinet’s Office of Financial Management

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Updated March 19, 2019

It’s Time for States to Invest in Infrastructure By Elizabeth C. McNichol

State investment in transportation, public buildings, water treatment systems, and other forms of

vital infrastructure is key to creating good jobs and promoting full economic recovery. States should reject the flawed economic growth strategy of cutting taxes and offering corporate giveaways, and instead identify and make investments in infrastructure that provide the foundation for a strong economy. It’s a good time for states to make those investments.

The condition of roads, bridges, schools, water treatment plants, and other physical assets greatly

influences the economy’s ability to function and grow. Commerce requires well-maintained roads, railroads, airports, and ports so that manufacturers can obtain raw materials and parts and deliver finished products to consumers. Growing communities rely on well-functioning water and sewer systems. State-of-the art schools free from crowding and safety hazards improve educational opportunities for future workers. Every state needs infrastructure improvements that can pay off economically in private-sector investment and productivity growth.

States may be hoping that a promised federal plan to invest more in roads, bridges, and other

public infrastructure will materialize. More federal help would be welcome, but states should take the lead in this area because the type and amount of assistance they’d receive under any new federal initiative remain unclear. The President’s fiscal year 2019 infrastructure proposal, for example, claimed to invest $1.5 trillion in real new federal infrastructure resources, but it is a mirage: the budget in fact would have cut total federal funding for infrastructure in the long run. (The proposal would have added $200 billion in “new” federal funds that the Administration claimed could support at least $1.5 trillion in investment, but in the long run it would have deeply cut the Highway Trust Fund — and suggests that states and localities would have to fill the gap.1) President Trump also noted the need for infrastructure investment in his 2020 budget, which again calls for allocating $200 billion but provides no new details on how it would be used.

But rather than investing in infrastructure, many states have cut taxes and have offered corporate

subsidies in a misguided approach to boosting economic growth. Tax cuts will spur little to no economic growth and take money away from schools, universities, and other public investments

1 Jacob Leibenluft, “Trump ‘$1.5 Trillion’ Infrastructure Plan Is a Mirage,” Center on Budget and Policy Priorities, February 12, 2018, https://www.cbpp.org/blog/trump-15-trillion-infrastructure-plan-is-a-mirage.

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essential to producing the talented workforce that businesses need.2 This pattern of neglect of infrastructure by states — the primary stewards (along with their local government partners) of the nation’s infrastructure — has serious consequences for the nation’s growth and quality of life as roads crumble, school buildings become obsolete, and outdated facilities jeopardize public health.

States should address unmet infrastructure needs now for several reasons:

• The investment will improve state economies, now and in the future. Higher-quality and more efficient infrastructure will boost productivity in states that make the needed investments, lifting long-term economic growth and wages. In the short term, even though overall employment has recovered, millions of Americans are working less than they would like and making less than it takes to get by. Key infrastructure investments would provide immediate job opportunities.

• Opportunities to finance infrastructure investment abound. States often pay for building new schools, roads, airports, water treatment facilities, and the like using debt, a sound practice for financing infrastructure that can serve generations. Today’s historically low interest rates are especially favorable to such borrowing, and state and local debt is below pre-recession levels. But with the Federal Reserve raising interest rates, this opportunity may diminish soon. States also have many other revenue sources available including user fees, like tolls, as well as federal grants.

• Most states are in a relatively strong position to afford these investments. The nation’s economy has slowly recovered from the Great Recession, finally lifting state revenues above pre-recession levels, better enabling states on average to afford infrastructure investments. The long recovery has improved state revenues significantly, but the pace of state tax growth is slowing.3 In many states revenues remain insufficient to adequately cover the costs of needed services such as education and health care, and still make the necessary infrastructure investments. These states will need to consider tax increases to preserve public capital that is crucial to long-term economic growth while meeting other needs.

A number of states have recognized the historic opportunity and need for infrastructure

investments. For example, Washington is in the midst of a multi-year transportation improvement initiative. And more than half of the states have raised their gas taxes, a key source of funds for road construction, since 2013.

But overall, states are cutting infrastructure spending as a share of the economy, the opposite of

what is needed. Spending by state and local governments on all types of capital dropped from its

2 For example, see Michael Leachman and Michael Mazerov, “State Personal Income Tax Cuts: Still a Poor Strategy for Economic Growth,” Center on Budget and Policy Priorities, updated May 14, 2015, http://www.cbpp.org/research/state-budget-and-tax/state-personal-income-tax-cuts-still-a-poor-strategy-for-economic. 3 Lucy Dadayan, “Another Stellar Quarter of State Revenue Growth, But the Pace Is Slowing Down,” Urban Institute, December 18, 2018, https://www.urban.org/research/publication/another-stellar-quarter-state-revenue-growth-pace- slowing-down/view/full_report .

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high of 3 percent of the nation’s gross domestic product (GDP) in the late 1960s to less than 2 percent in 2017. Falling federal spending on infrastructure is exacerbating the problem.

States must turn their attention back to the type of infrastructure investments that will boost

productivity, support business growth, create jobs, provide a healthier environment, and improve opportunities for all of their residents. The specific investments needed will differ from state to state depending on factors like the condition of the existing infrastructure and the mix of industries in the region, but states continue to ignore needed investments at the country’s peril.

Investment in Public Infrastructure Is Falling, With Real Consequences

In the decades after World War II, the United States built an interstate highway system, hundreds of airports, a massive network of waterworks, and expanded port facilities and other infrastructure that significantly boosted the country’s economic output. Much of this infrastructure is in dire need of repair. In addition, better functioning infrastructure, including more efficient public transit systems and more environmentally friendly water and sewer systems, could boost economic growth and quality of life. Despite these needs, governments at all levels are failing to make the improvements that the nation’s roads, bridges, and other infrastructure need.

The Nation’s Infrastructure Needs Improvement

Across the United States, years of neglect have resulted in crumbling roads, bridges in need of repair, inadequate public transport, outdated school buildings, and other critical infrastructure needs.

In its most recent report card on the condition of America’s infrastructure, the American Society

of Civil Engineers (ASCE) gave U.S. infrastructure a D+ or “poor” rating. The engineers estimated the cost of bringing America’s infrastructure to a state of good repair (a grade of B) by 2025 at $4.6 trillion, of which only about 55 percent has been committed.4 Improving roads and bridges alone would require $1.1 trillion more than states, localities, and the federal government have allocated. Schools need another $380 billion beyond what’s been invested. (See Figure 1 and Table 2 in the Appendix.)

Other studies have supported and built on the ASCE findings. For instance, America’s drinking water treatment and distribution systems need $473 billion in investments over the next 20 years, according to the Environmental Protection Agency.5 Over half of America’s public schools need to be repaired, renovated, or modernized, according to a U.S. Department of Education survey.6 And almost 20 percent of the country’s roads are in poor condition, according to the Federal Highway Administration’s most recent survey.7

4 2017 Report Card for America’s Infrastructure, American Society of Civil Engineers, March 2017, http://www.infrastructurereportcard.org/. 5 Drinking Water Infrastructure Needs Survey and Assessment, U.S. Environmental Protection Agency, March 2018. 6 Condition of America’s Public School Facilities: 2012-13, U.S. Department of Education, NCES 2014-022, March 2014. 7 U.S. Department of Transportation, Office of Highway Policy Information, Highway Statistics 2017, Table HM-63, https://www.fhwa.dot.gov/policyinformation/statistics/2017/.

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FIGURE 1

These needs vary significantly by state because of differences in size, congestion, and age of existing infrastructure. For example, 54 percent of the roads in Rhode Island are in poor condition, while only 9 percent of roads in North Carolina are, according to ASCE. Ohio needs over $100 billion to improve its drinking water treatment facilities while Georgia — with a population similar to Ohio — needs just over $20 billion. The ASCE report card also includes information on state infrastructure needs and investment.8

8 American Society of Civil Engineers (ASCE), 2017. State-specific report cards are also prepared but the release schedule varies. The “Sources” for the state information on the ASCE website include links to state-by-state data from various sources; see http://www.infrastructurereportcard.org/americas-grades/fact-sources/.

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State and Local Governments Are the Primary Stewards of the Country’s Infrastructure

State and local governments are the stewards of most of the country’s public capital.

They own over 90 percent of non-defense

public infrastructure assets,9 and although the federal government assists in the building and maintenance of these assets, state and local governments pay 75 percent of the cost of maintaining and improving them.10 (See Figure 2.)

States and localities spend the vast majority of

their capital dollars — 85 percent — on key building blocks of a state’s economy: schools, transportation, and drinking water treatment and distribution. (See Table 1.)

Not surprisingly, current investment varies

significantly by state, based on factors like the size and population density of a state or the age of existing infrastructure. But some differences result from the willingness of the state to identify and fund needed investments. Overall, investments have been declining as needs have risen. Figure 3 shows the portion of total state spending devoted to capital spending in 2014. Several large states with small populations — Alaska, North Dakota, South Dakota, and Wyoming — spent over 15 percent of their budget on capital expenses. At the other end of the spectrum, three states — Michigan, Rhode Island, and New Hampshire — spent less than 7 percent.

9 CBPP calculations of Bureau of Economic Analysis data on Fixed Assets, 2015. 10 Statement of Peter R. Orszag, Director, Congressional Budget Office, before the Committee on Finance, United States Senate, “Investing in Infrastructure,” July 10, 2008; CBPP calculations of data in Table 1.

FIGURE 2

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TABLE 1

State and Local Governments Account for Nearly 75% of Public Infrastructure Spending (billions, 2004)

Public

Federal State and Local Private

Schools $0.4 $75.5 $23.8 Highways 30.2 36.5 n/a Drinking Water 2.6 25.4 n/a Mass Transit 7.6 8.0 0.0 Energy 1.7 7.7 69.0 Telecommunications 3.9 n/a 68.6 Other 16.1 17.2 12.1 Total $62.5 $170.3 $173.5

Source: Congressional Budget Office, 2008

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FIGURE 3

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How States Pay for Infrastructure Projects States pay for public buildings, facilities, roads, and other infrastructure somewhat differently than they fund other types of spending. For example, they use debt more frequently and often rely on user fees like tolls to fund infrastructure. In addition, the federal government provides grants for roads, transit, and other infrastructure. But state revenues are required, regardless of the funding method that’s used. Borrowing must be repaid and federal grants often require matching funds.

Borrowing. There are sound reasons why states and localities borrow to pay for infrastructure, rather than use annual tax collections and other revenues. Public buildings, roads, and bridges are used for decades but entail large upfront costs; borrowing enables the state to spread out those costs. As a result, taxpayers who will use the infrastructure in the future help pay for it, which promotes intergenerational equity. Borrowing also makes infrastructure projects more affordable by reducing the pressure on a state’s budget in any given year. On average, states finance 27 percent of their capital spending with bond proceeds.

Some states, either by law or by tradition, do not usually issue general obligation bonds for infrastructure or other spending. Twenty-two states report that they maintain a formal or informal policy of funding infrastructure on a pay-as-you-go basis, according to a 2014 National Association of State Budget Officers (NASBO) survey.a This means they look exclusively or primarily to cash on hand from taxes, fees, grants, or other sources to pay for capital projects. Bond proceeds make up less than 10 percent of funding for capital projects in 16 states.b

Taxes and Fees. On average, states finance only a small share (5 percent) of infrastructure with general fund taxes (typically sales or income taxes not designated for specific purposes). However, this practice varies by state. States that shy away from borrowing for infrastructure projects depend much more heavily on general fund taxes to pay for building and maintaining

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infrastructure. General fund spending makes up more than 20 percent of funding for capital projects in six states — Colorado, Georgia, Indiana, New Jersey, Tennessee, and Wyoming.b

More typically, the general fund share is small and other state funds make up over a third of funding for capital projects. This includes taxes designated for infrastructure such as gas taxes or user fees like tolls, water and sewer fees, or facility entry fees.

Grants. The federal government is an active partner with states in building and maintaining infrastructure. States use federal grants to pay for some 28 percent of their infrastructure spending. The federal government provides grants for road and public transit projects, for utilities, and a host of other capital expenditures.

Public-Private Partnerships. In addition, the private sector sometimes partners with states and localities to jointly fund a needed infrastructure project. Or, in some cases, the private sector builds or maintains a road or a public facility in return for collecting tolls or other user fees associated with the facility. (Any state spending related to public-private partnerships is not identified separately by NASBO in the chart above.) a National Association of State Budget Officers, “Capital Budgeting in the States,” Spring 2014.

b National Association of State Budget Officers, “State Expenditure Report,” 2017.

Infrastructure Spending Is Down Across Government

Federal infrastructure investment has fallen by half ― from 1 percent to 0.5 percent of GDP ― over the last 35 years, leaving more of the task to state and local governments.11 For example, federal spending on transportation and water infrastructure has fallen in real terms since 2003, and the federal gas tax has not been increased since 1992. The five-year federal transportation bill enacted in 2015 falls short of providing the amount needed to maintain and expand the nation’s road system. And even the new investments in the 2015 legislation will be at risk in future years because they are paid for with cuts in other parts of the budget, rather than an increase in the gas tax. The Congressional Budget Office estimates that the federal Highway Trust Fund will be insolvent after 2021; that is, the projected costs will exceed revenue from federal gas and other taxes and interest generated by the fund.12

11 Jared Bernstein, “I (mostly) like Hillary’s Infrastructure Plan,” Washington Post, December 2, 2015. 12 Congressional Budget Office, Highway Trust Fund Accounts — CBO’s January 2019 Baseline, https://www.cbo.gov/system/files?file=2019-01/51300-2019-01-highwaytrustfund.pdf.

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FIGURE 4

In the 1990s, when the economy was particularly strong, states and localities increased their

investments. But this trend ended after the turn of the century, except for a temporary boost fueled by federal infrastructure funding to states and localities from the 2009 Recovery Act. Spending by state and local governments on all types of capital fell from 2.4 percent of GDP in the early 2000s to 1.87 percent in 2017 and is now lower than it has been since the 1950.13 (See Figure 4.)

Total capital spending as a share of state GDP fell in all but nine states between 2002 and 2016,

with the largest drops in Nevada, Arizona, Utah, and Florida. These states’ revenues were hit particularly hard by the Great Recession, resulting in cuts in all parts of the budget, especially after the federal Recovery Act funds were depleted. But capital spending has not bounced back in these states — or most others — even as the economy has recovered. (See Figure 5.)

13 CBPP analysis of Census Government Finances and Bureau of Economic Analysis data.

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FIGURE 5

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Investment in Public Infrastructure Fuels Economic Growth The condition of roads, bridges, schools, water treatment plants, and other physical assets greatly

affects the economy’s ability to function and grow. Commerce requires well-maintained roads, railroads, airports, and ports so that manufacturers can obtain raw materials and parts, and deliver finished products to consumers. Improving many types of public infrastructure boosts the productivity of businesses by reducing their costs. Growing communities rely on well-functioning water and sewer systems. State-of-the art schools free from crowding and safety hazards improve educational opportunities for future workers. Better roads and public transit make it feasible (or more efficient) for workers to get from their home communities to more of the places where the jobs are. Carefully targeted initiatives to maintain and improve public infrastructure boost a state’s long-term productivity, resulting in more economic growth and higher-wage jobs. In the short term, when conditions are right, public infrastructure investments also can create needed jobs.

Well-Targeted Public Investment in Infrastructure Improves

Private Productivity, Research Shows Recent research has found that infrastructure investments generally result in a more productive

economy, which typically means higher wages and a better quality of life. The interactions between public infrastructure investments and private-sector growth are,

however, highly complex and difficult to quantify. Early studies on the topic showed mixed results,14 but on balance, studies conducted between the late 1990s and 2007 tended to confirm a relationship between public infrastructure investment and economic growth. “Although not all studies find a growth-enhancing effect of public capital, there is more of a consensus in the recent literature than in the older literature,” a 2007 survey of over 75 studies of the relationship concluded.15

The search for ways to restore economic growth following the 2007-09 recession prompted

additional research on this topic. Many of these more recent studies found that spending on public infrastructure has a positive and statistically significant effect on productivity and, thus, economic growth.16 Although the magnitude of the effects found in individual studies differed, the general

14 A groundbreaking analysis by economist David Aschauer of the country’s economic and public infrastructure growth between 1949 and 1985 found that a 10 percent increase in public-sector capital stock (such as roads, transit, and public buildings) increased productivity growth by almost 4 percent. See David Aschauer, “Is Public Expenditure Productive?” Journal of Monetary Economics, Vol. 23, 177-200, 1989. Some researchers, skeptical of this finding, conducted studies using different data sets and methods, which found considerably smaller effects than the early work or no effect at all. See for example: Alicia Munnell, “Infrastructure investment and economic growth,” Journal of Economic Perspectives, Vol. 6 (4), 1992, 189-98; Douglas Holtz-Eakin, “Public-Sector Capital and the Productivity Puzzle,” Review of Economics and Statistics, Vol. 76 (1), 12-21; and Teresa Garcia-Mila, Therese McGuire, and Robert Porter, “The Effect of Public Capital in State- Level Production Functions Reconsidered,” Review of Economics and Statistics, Vol 78 (1), 177-180. 15 Ward Romp and Jakob de Haan, “Public Capital and Economic Growth: A Critical Survey,” Perspektiven der Wirtschartspolitik, Vol. 8, 2007, 6-52.

16 James Heintz, “The impact of public capital on the U.S. private economy: new evidence and analysis,” International Review of Applied Economics, Vol. 24 (5), 2010, 619-632. Also see Jeffrey Thompson, “Prioritizing Approaches to

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findings of the most recent studies are that an increase in the value of existing current capital stock (roads, bridges, and other infrastructure) would increase productivity growth.17

Economists prepared a number of estimates of the impact of an additional dollar of infrastructure

spending on GDP growth in 2008 during the debate over a federal fiscal stimulus package. These estimates found that in the depths of the Great Recession, a dollar in infrastructure investment would result in $1.50 in GDP growth, according to the Council of Economic Advisers.18 Similarly, Moody’s, a leading private econometric firm, estimated the effect at $1.60.19 The Congressional Budget Office found that that the impact ranged from a low estimate of $1.00 to 2.50.20

Even when the economy is at or near full employment, investment in infrastructure increases the

productivity of companies and workers and thus the rate of growth of the economy. This is especially true now when there is such significant room for improvement in the country’s transportation, water treatment, and other assets. Poor roads, bridges, and transit greatly influence a company’s ability to do business. Outdated water treatment systems and schools hurt the health and quality of life of a community and its residents.

Other key points for state policymakers to keep in mind include:

• A portion of the economic benefits may spill over into neighboring states. The majority of the studies of the effects of infrastructure investment focus on national spending, but some have looked specifically at the effect of infrastructure spending in U.S. states or cities.21 Generally, the effect of state infrastructure spending on economic growth was found to be different — often somewhat smaller — than the effect of federal spending because of something called the “spillover” effect. That is, the benefits of improving the roads or other infrastructure of one state may spill over to neighboring

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