Innovative Financing For Roads and Highways

Summer 2017 Issue
By: Robert T. Dunphy
The LBJ Express project, developed through a public-private partnership (P3) between the Texas Department of Transportation and the LBJ Infrastructure Group LLC, features variable fluctuating pricing based on traffic demand. The largest public-private project in Texas, it has eased traffic congestion in the Dallas-Ft. Worth region. Stephen Gould, Aperture Photography

New approaches are needed to fix an old problem.

U.S. HIGHWAYS ARE financed with a broad array of federal and state fuel taxes and motor vehicle fees, an unusual arrangement compared to most government services such as schools and libraries, which compete for funding out of general revenue. This highway funding system once worked well to sustain a critical element of the economy. Today, however, the system is threatened by increased fuel economy, which results in decreased fuel tax revenues; a proliferation of electric and hybrid vehicles, whose owners pay little or no gas taxes; political opposition to raising taxes and fees; and the introduction of shared vehicles via services like Zipcar and Car2Go as well as ride-hailing services like Uber and Lyft.

So far, federal transportation funding has avoided addressing this fundamental problem; instead, it has managed to find a workaround, most recently a general fund transfer financed, as described below, by reducing the surplus account of the Federal Reserve and the dividends paid to banks. The fact that investment in infrastructure was an important issue in the 2016 presidential election may augur positive change for the future. In the meantime, a growing number of innovations are providing smaller fixes to this overarching financing problem.

The Current Funding Situation

The nation’s local, state and federal governments spent a combined $238 billion for highway-related purposes in 2014. About 47.5 percent of total highway spending was for capital improvements to highways and bridges. Much of this money funded reconstruction and improvement of existing facilities rather than new construction.
Fuel taxes and fees paid by car and truck owners and drivers have been the primary source of funding for both federal and state highway revenues. As shown in the top chart on page 72, federal highway revenues come almost exclusively from taxes on cars and trucks, with a significant transfer from the general fund in 2014. As shown in the middle chart, by 2014 the three key sources of state highway funding — taxes and fees on cars and trucks, tolls, and investment revenue — accounted for 80 percent of revenues. More than half of local highway revenue comes from the general fund, as shown in the bottom chart, while about one-sixth comes from property (real estate) taxes, and the remainder from a variety of local revenue sources.

highway funding chart

The portion of federal highway spending funded by taxes dropped by 50 percent during the Great Recession, but was restored with additional general fund transfers. Taxes and fees paid by vehicle owners and drivers, along with tolls, account for a slightly lower share of state transportation budgets, but saw a less precipitous decline during the recession and have been recovering since then, boosted in part by federal stimulus funding as part of the American Recovery and Reinvestment Act beginning in fiscal year 2010.

Federal transportation funding has traditionally come through multiyear legislation, which gives states the long-term support needed to undertake large projects requiring many years to complete. In recent years, however, Congressional gridlock prevented these kind of bipartisan agreements, until President Obama signed the Fixing America’s Surface Transportation (FAST) Act on December 4, 2015. The act authorized surface transportation programs through 2020 and provided $281 billion, subject to annual appropriations over the five-year period. (See “Congress Finally Acts on Transportation Investments,” Development, spring 2016.)

The FAST Act did not rely on taxes and fees from auto and truck drivers and owners; it did not create any new revenue sources from transportation users. Instead, it transferred $70 billion from the general fund of the U.S. Treasury to the Highway Trust Fund (HTF). This funding was financed by budgetary gimmicks: reducing the surplus account of the Federal Reserve and the dividends paid to large member banks on their capital stock in the Federal Reserve. And this level of funding is still inadequate; the Congressional Budget Office projects that, under the FAST Act, both the highway and transit accounts of the HTF will be unable to meet all obligations in 2021.

The Gas Tax: A Flawed Foundation

The Highway Trust Fund was created as a user-supported fund when Congress established the interstate highway system in 1956. (Before then, revenues from taxes on motor fuels and automotive products went to the general treasury.) The Federal Aid Highway Act of 1956 directed that the HTF be supported by highway users. (Revisions in 1982 established a special Mass Transit Account in the HTF to receive part of the motor fuel tax.) The taxes were raised occasionally, most recently in 1993, reaching 18.4 cents a gallon.

The current system of fees on gasoline and diesel fuel, with several other user charges, is threatened by technology, inflation, driving trends and political will. Since the federal gas tax has been fixed at 18.4 cents per gallon since 1993, its purchasing power has declined by almost 40 percent. According to Ed Regan, senior vice president of transportation consulting firm CDM Smith, if one takes into consideration the effect of federally mandated fuel efficiency standards and gas tax revenues lost to electric cars, fuel tax revenues will drop by $40 billion by 2040.

The number of vehicle miles traveled (VMT) on the nation’s highways declined by 3.6 percent between November 2007 and 2012. Total travel seems to have recovered since then, to 3.2 trillion vehicle miles annually. Per capita driving, which declined from about 10,000 miles annually in 2007 to about 9,500 in 2012, recovered to about 10,000 in 2015, much to the chagrin of those who believed that a fundamental change in personal travel habits had taken place. It continues to increase as vehicle travel, up another 2.5 percent in 2016, grows faster than the population.

Adjusting the gas tax rate would be a simple fix for many of these problems, but that solution runs afoul of political will among elected officials of all stripes. Most view even an adjustment in this consumption tax as “raising taxes,” something that is anathema to a public widely perceived as tax averse.

What Is the Alternative?

The transportation community has done better at estimating future funding needs than at developing consensus on how to pay for them, and expanding facilities to serve growth competes with a backlog of needs from deferred maintenance. Such a backlog acts as a barrier to the introduction of innovative projects, at least if they wish to use traditional financing. A recent evaluation of combined highway needs estimated it would cost $120 to $156 billion annually, depending on traffic growth, in capital investments by all levels of government to begin to address future needs, in addition to recent spending of $88 billion annually. (See “2015 AASHTO Bottom Line Report,” American Association of State Highway and Transportation Officials.)

The one-third increase at the low end would seem manageable, especially if introduced over several years, if not for the resistance to any increase in taxes or fees noted above. Over the long term, this critical funding gap will have to be addressed. As of late March, the Trump administration’s proposed $1 trillion infrastructure program to improve highways, transit, airports, and many other areas of infrastructure is slowly taking shape. Funding, however, appears to be a sticking point, and fixing the Highway Trust Fund by increasing taxes is not yet on the agenda. While Rep. Peter DeFazio, D-Ore., has proposed increasing the federal gas tax by up to 1.5 cents per year, with proceeds going to pay interest on an annual surface transportation bond issue of $17 billion through 2030, a March 26 Washington Post editorial called this increase “almost laughably modest, given that the failure to raise the tax for the last quarter-century amounts to a 40 percent cut in real terms.”

New Approaches for a New Era

Yet a number of innovative approaches to funding highways are already in practice, while others are under consideration. The apparently broad support at the federal level for aggressive infrastructure investments brings hope that a quarter-century of deadlock in funding highways will be broken. Some of the ideas in the works include the following:

595 express

The reversible toll lanes known as 595 Express have eased traffic congestion between Ft. Lauderdale and its western suburbs in South Florida. The lanes were constructed by a P3 between the Florida Department of Transportation and ACS Infrastructure Development Inc.

Tolling the Interstate Highway System. Many transportation advocates believe this is the “holy grail” of funding solutions. Tolling only the urban portions of the interstate system would generate about $40 billion annually, according to the Congressional Budget Office. U.S. Department of Transportation Secretary Elaine Chao signaled in an interview in February that tolling is an idea being considered, without specifically endorsing tolls on interstate highways.

Charging by the Mile. One idea favored by many analysts and virtually all economists is charging motorists costs that reflect the impacts they impose on the transportation system. A mileage-based user fee system would calculate fees based on the actual vehicle miles traveled (VMT), rather than simply the number of gallons of fuel used.

Increasing State Funding. Like the federal government, most states have so far resisted raising the gas tax. A growing number, however, have done so, including Pennsylvania, New Jersey, Maine and Washington. These states have demonstrated that higher state gas taxes can generate significant funds, all of which the states get to keep. (See “State Funding” below.)

Creating or Expanding Regional Toll Authorities. The nation’s fewer than 6,000 miles of toll roads make up about 1 percent of the federal highway system. Most of these toll roads are state-operated through routes. Fourteen states, however, have toll roads operated by regional entities. Some of these represent a large share of their region’s transportation capacity. (See “Regional Toll Authorities” below.)

Implementing Public-private Partnerships. There is growing interest in public-private partnerships (P3s) that integrate design, construction and operation — including long-term maintenance — of a public facility such as a highway to a private operator. This operator typically has some “skin in the game”; in other words, the project’s financial structure includes a slice of private equity. In order to attract private investors, revenue must be generated from tolls or other sources, a situation that is uncommon for most of today’s major highways. (See “P3s” below.)

Creating a Carbon Tax. The idea of taxing travel according to the amount of carbon emitted is a wonky idea long popular with economists and environmentalists. But it is now receiving some new, broader support. Liberals appreciate the focus on the impacts of climate change, while conservatives prefer taxation to government environmental regulation. A 2017 report by the U.S. Treasury estimates that a “midrange” tax of $50 per metric ton would generate $250 billion annually, a major windfall if it were used for infrastructure improvements.

However, if a large windfall from such a policy were obtained, it is unlikely that all or even most of it would be used to invest in infrastructure. More likely, as proposed by a group of former Republican officials in February, most of the $250 billion would be returned to consumers as a revenue-neutral expense, creating a rebate of $2,000 per family.

Simple Software, More Equitable Funding?

Autonomous cars and some simple tracking software, as well as changes in vehicle ownership patterns, may soon force the nation to consider new funding mechanisms. As federal, state and local governments are attempting to find a secure fix for the nation’s highway funding, automobile companies are preparing to roll out a new generation of cars and trucks with technology that will transform the driving experience, as well as ownership models that may make the family car irrelevant. Instead of the expense of buying, maintaining, insuring and operating a household vehicle that gets used less than an hour a day, the near future will offer affordable shared mobility options for taxi service or rental by the trip.

Reimagined highway funding could build off of the current practice of using gas and diesel taxes, applied at the point of purchase, with some equitable tax or fee added for electric vehicles. Simple software can now measure — and be used to apply different user fees — for peak versus off-peak travel, urban versus rural roads and so forth. This software could be used to develop a much more nuanced and equitable system, if the political will to do so exists. But fairness is not necessarily politically expedient.

A substantive attack on the central problem, inadequate user funding, will require significant increases in the costs to users, and there has been no sign to date of a serious national initiative to increase those charges to make highway funding sustainable again. Politically popular ideas have depended on what real estate people recognize as OPM — other people’s money — such as juggling Federal Reserve requirements, carbon taxes or repatriation of overseas earnings of American companies. Lacking any miraculous breakthrough, there will be a growing need for innovative projects that charge tolls and other fees, allowing them to be financed as public-private projects.

Robert T. Dunphy, a transportation consultant and emeritus fellow, Transportation Research Board

State Funding

Opportunities for significant increases in infrastructure funding clearly exist at the state level; 19 states and the District of Columbia have increased their gasoline taxes in recent years. These opportunities are, however, dependent on political support. 

In 2013, the Pennsylvania General Assembly (the commonwealth’s legislature) enacted a 19 cent per gallon increase in the state gas tax, which was expected to generate $2.3 billion for roads annually by 2019, the fifth year of the plan, as well as significant increases for public transportation. This was expected to finance improvements to thousands of bridges and 1,000 miles of roadway, as well as provide investment in statewide public transportation to avoid crippling budget cuts. By January 2017, nearly 950 road and bridge construction projects were underway statewide, according to a January 2 Lancaster Online editorial titled “Why the Pennsylvania Gas Tax Increase Isn’t So Bad.”

New Jersey’s legislature and Governor Chris Christie agreed in 2016 to a deal that increases the gas tax by 23 cents per gallon, from the second lowest in the U.S. (14.5 cents), to the seventh highest (37.5 cents). The revenue will finance an eight-year, $16 billion transportation program which, with additional federal funding, will increase to $32 billion. To make such increases in taxes a bit more acceptable, the deal also included a number of tax cuts, including a reduction in the sales tax, increases in the earned income tax credit for low-income workers, a reduction in retirement taxes and a veterans’ exemption, as well as the elimination of the estate tax. Christie said this will be the longest and largest reauthorization in the state trust fund’s history.

An added benefit of increasing state, as opposed to federal, gas taxes is that all the additional revenue stays in the state. One of the shortcomings of such a state-centered approach is that it precludes a focus on nationally significant projects, which additional federal funds could support.

Regional Toll Authorities

Some regional toll authorities represent a large share of their region’s transportation capacity. The North Texas Tollway Authority, for example, operates 966 lane miles of toll roads in Dallas-Fort Worth and the Central Florida Expressway Authority operates 767 lane miles of toll facilities around Orlando and carries two-thirds of all freeway travel in the region. Such highways offer opportunities to provide much-needed capacity to quickly serve patterns of regional growth without either federal or state funds.

Fourteen other states, including California, Colorado, Virginia, New York, Pennsylvania and Illinois, also have toll facilities operated by regional organizations. They demonstrate that toll roads, despite initial resentment among residents, can play an important role in regional transportation networks.

Public-private Partnerships (P3s)

There have been 34 public-private partnership contracts for major construction projects in the U.S. over the last 30 years, according to Public Works Financing newsletter. The newsletter’s editor, William Reinhardt, writing in the November 2016 issue, attributes the scarcity of such projects to a lack of public investment capital as well as general distrust of the private sector’s profit motive. A successful program at the national level might be able to overcome such inertia.

In order to cope with growing traffic congestion on Interstate 595 between Ft. Lauderdale and the western suburbs in South Florida, the Florida Department of Transportation (FDOT) decided to develop the I-595 Corridor Improvements Project as a P3. This $1.8 billion project, developed between 2009 and 2014, has relieved traffic congestion and created a multimodal transportation network along I-595 in South Florida.

A major component of the P3 project was the construction of three at-grade reversible express toll lanes known as 595 Express, which serve express traffic to/from the I-75/Sawgrass Expressway from/to east of state Route 7, with a direct connection to the median of Florida’s Turnpike. These lanes are operated as managed lanes with variable tolls to optimize traffic flow, and reverse direction in peak travel times (eastbound in the morning and westbound in the evening).

The project also included the reconstruction and widening of the I-595 mainline and all associated improvements to frontage roads and ramps from the I-75/Sawgrass Expressway interchange to the I-595/I-95 interchange, for a total project length of approximately 10.5 miles. FDOT selected ACS Infrastructure Development Inc. to design, build, finance, operate and maintain the roadway for a 35-year term. Teachers Insurance and Annuity Association of America (TIAA) became a 50 percent equity partner in 2015.

According to Kelley Hall, who served as FDOT’s assistant manager for the project, it “has been seen as a success on both the DOT and concessionaire sides. Non-compliances related to performance issues have been very minimal, and the public also seems very pleased with the customer service they receive.”

FDOT provides management oversight of the contract; installed, tested, operates and maintains all tolling equipment for the express lanes; and sets the toll rates and retains the toll revenue.  The concessionaire receives three types of payments:

1) Final Acceptance Payments totaling $634 million over the first five years after construction.
2) Milestone Payments for expedited completion of construction activities, totaling $50 million.
3) Performance-based Maximum Availability Payments for assuring that the lanes are available for use. These payments may total up to $66 million annually, beginning in 2014 and continuing until 2043.  If the lanes are closed for two hours during rush hour, for example, $24,000 is deducted from the availability payment. Deductions are also taken if the concessionaire fails to maintain agreed upon operations and maintenance standards. 
Funding sources for the $1.8 billion project included FDOT, federal funding, bank debt of $781 million and $207 million in equity by the concessionaire, ACS Infrastructure. The financing closed in 2009, at the peak of the U.S. banking crisis, demonstrating the financial markets’ confidence in the project.

In the Dallas-Ft. Worth region, Texas Department of Transportation (TxDOT) officials executed a comprehensive development agreement (CDA) with the LBJ Infrastructure Group LLC in 2009 to design, construct, finance, operate and maintain the 13-mile LBJ-635 corridor in Dallas County. With a price tag of $2.6 billion, this was the largest public-private project in Texas.

The project began in 2011 and involved reconstruction of all of the main and expanded frontage lanes of Interstate 635. It added new managed toll lanes (TEXpress lanes) along this 13-mile stretch, as well as direct connectors to managed lanes on I-35 east from Loop 12 to I-635. The LBJ Express project, which opened in 2015, features variable fluctuating pricing based on traffic demand, to help maintain speeds. The LBJ Infrastructure Group is made up of Cintra, Meridiam Infrastructure, APG and the Dallas Police and Fire Pension System. Financing came through four main sources, including an $850 million loan from the U.S. Department of Transportation’s Transportation Infrastructure Finance and Innovation Act (TIFIA), $490 million from the Texas Department of Transportation (TxDOT), $664 million from investor funds and $615 million from private activity bonds.