Go to... Home Federal Credit Concepts & Issues State Infrastucture Banks Quarterly Newsletter TE-045 Research Innovative Finance Program Guidance

1.0 Executive Summary

1.1 Results in Brief

In the early 1990s, the U.S. Department of Transportation (DOT), recognizing the need to expand investment in the nation's transportation infrastructure, launched a comprehensive initiative to create new funding tools and expand flexibility of the Federal-aid highway funding program. This "innovative finance" initiative was an attempt to meet the increasing gap between transportation capital needs and available resources, without direct increases in Federal grant funding. The initiative also responded to states' calls for greater flexibility in the use of their Federal-aid funds.

Nearly a decade later, at least $29.1 billion in innovative finance projects have been advanced, which were supported by $8.6 billion in Federal-aid funding. On average, for each Federal dollar invested in an innovative finance project, $3.40 of construction investment has been enabled, which compares quite favorably to the ratio of $1.25 to $1.00 for every dollar invested in the traditional grant program. This "leveraging ratio" is an important indicator of the effectiveness of Federal-aid funding. Simply put, greater lever-aging means that each dollar invested has gone further - building more projects for the same amount of Federal-aid funding. Table 1.1 summarizes the leveraging and other quantitative results of this evaluation, which are explained in detail in the rest of this report.

Table 1.1 Summary of Quantifiable Results: Evaluation of Innovative Finance

This analysis provides the first comprehensive evaluation of U.S. DOT's innovative finance program since its inception. The results in this report should help guide both Federal policy makers, as they continue to improve and enhance Federal surface transportation programs, and state and local officials, as they continue to make use of these programs to advance critical transportation projects.

1.2 Background: The Federal Role in Highway Finance

"Innovative finance" for transportation is a broadly defined term that encompasses a combination of specially designed techniques that supplement traditional highway financing methods. While many of these techniques may not be new to other sectors, their application to transportation is innovative.

The emergence of innovative financing approaches over the last decade has comple-mented a gradual national shift towards a more broad-based and diverse highway funding environment. Table 1.2 illustrates the change in the Federal role by depicting Federal aid to highway capital projects as a percentage of total funding over the last four decades. In 1960, state and local agencies made total capital outlays of $6.1 billion on highways, and received $2.9 billion in revenue transfers (grants) from the Federal gov-ernment. Thus, Federal revenues represented approximately 48.4 percent of capital out-lays in 1960. By the year 2000, capital outlays by state and local agencies had increased to an estimated $62 billion. While Federal revenues provided to states also increased sub-stantially, to $24 billion, the percentage of total funding had declined to under 40 percent.[1]

While these percentages tend to fluctuate, the general trend has been for greater variety in both revenue sources and leveraging tools used for transportation. Although Federal-aid funding continues to increase, and will continue to be a critical part of highway construction programs, other sources of revenue have become as important and are expected to reflect even greater growth to meet highway needs.

Table 1.2 Highway Finance Statistics: Relative Share
(Dollars in Millions)

The Increasing Investment Gap

Transportation investment needs have consistently outpaced available funds, despite increases in funding at both the Federal and state levels. The latest official conditions and performance report from the Federal Highway Administration (FHWA) indicates that transportation investment would have to increase by 19.2 percent just to maintain the system at its current state, and by 92.9 percent in order to produce needed improvements (see Table 1.3).

Table 1.3 Comparison of Transportation Spending and Investment Needs: Quantifying the Gap

Source: Federal Highway Administration, Highway Conditions and Performance Report, 1999.

Federal rules and corresponding state procedures developed under the traditional Federal aid highway program have not always allowed states to combine new revenue sources and funding tools in ways that met their increasing project needs. Restrictions on the obligation of Federal-aid funds required states to manage their Federal funding very differently from their other funds, creating inefficiencies from a cash management perspective. For example, just prior to the end of a state fiscal year, a state DOT might have a significant balance of Federal-aid funds, but no state funding available for a non-Federal share. Prior to innovative finance, a state DOT in that position might lose the Federal funding, because it did not have the ability to match the Federal share of the project, even if the state funding would be available in a matter of weeks or days.

Moreover, while Federal-aid funding may fluctuate as a percentage of total capital outlay by states, its influence reaches far beyond its numerical share. For administrative ease, many states will design most highway projects to satisfy Federal-aid requirements, whether financial, environmental, or legal. This allows them greater flexibility when there is uncertainty about the ultimate source of funding for a project. Yet if state projects, accounting practices, programs, and institutions are based on the model of the historical Federal-aid program, both Federal and non-Federal projects will be affected by any barri-ers inadvertently created by historical regulatory restrictions. Conversely, increased financial flexibility in Federal programs can have a ripple effect, creating benefits beyond the projects that are actually paid for with Federal-aid funds.

Creating New Models For Federal Transportation Investment

Recognizing the need for change, U.S. DOT and FHWA began to consider ways to remove barriers and transform the Federal role with respect to transportation finance. The tradi-tional model of constructing Federally-assisted projects solely with Federal grant reimbursements of costs incurred by the states, with a standard matching requirement will continue to play a key role. Yet innovative finance has created complementary models to address particular kinds of projects that may benefit from alternative funding approaches, including credit assistance and bond financing. These include projects with revenue potential from user fees or tolls, private equity participation, or national significance.

The impetus for these new approaches to Federal funding strategies lay both in a growing recognition of the gap between resources and investment needs and an improved under-standing of the economic value of transportation investment. A series of analyses has consistently demonstrated that each dollar invested in the transportation system pays dividends to the public in many forms, including improved industrial productivity, more efficient freight movement, new jobs, travel time savings, safety improvements, and for some projects, congestion relief and attendant environmental benefits [2] . Based on these findings, policy-makers recognized that it would be desirable both to accelerate project development, thereby bringing the associated benefits to bear sooner, and to expand investment in transportation infrastructure without additional Federal-aid funding. These objectives shaped the direction of the innovative finance initiative and provide a useful way of looking at the resulting efforts and accomplishments of the past decade.

Recognizing these benefits, FHWA initiated its innovative finance initiative, seeking to:

• Accelerate projects by reducing inefficient and unnecessary constraints on states' management of Federal highway funds; and
  
  
• Expand investment by: 1) removing barriers to private investment in surface trans-portation infrastructure, 2) encouraging the introduction of new revenue streams, par-ticularly for the purposes of retiring debt obligations, and 3) reducing financing and related costs, thus freeing up the savings for investment into the transportation system itself.

Table 1.4 aligns these goals to the new tools that have been developed. Eight years after the beginning of this effort in 1994, this report reviews how well the program has met the above goals, and whether additional changes to the tools created could bring even greater results. The report also seeks to identify any areas where the Federal effort has been less successful, in order to provide a guide to direct future investment and policy discussions.

Table 1.4 Innovative Finance Goals

The Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA) laid the ground-work for innovative finance through the introduction of several new concepts designed to increase transportation investment. These included the Section 1012 loan program (later codified as Section 129 of Title 23 of the U.S. Code), which allowed states to use regular Federal-aid apportionments to fund direct loans to projects with dedicated revenue streams; opportunities to levy tolls on Federally-supported highways; and permitting certain toll revenue expenditures to serve as a credit against non-Federal matching requirements.

In 1994, Executive Order 12893 established more cost-effective infrastructure investment as a priority for all Federal agencies. The Executive Order prompted more systematic analysis of the costs and benefits of proposed infrastructure investments; efficient man-agement of infrastructure; encouragement of private sector participation in infrastructure investment; and encouragement of more effective state and local programs. In response to that Executive Order, U.S. DOT and FHWA undertook a major initiative in 1994 to pro-mote and facilitate infrastructure investment.

This initiative was launched with the introduction of an experimental "Test and Evaluation" program, designated as TE-045, to solicit ideas from the states on a range of new financial strategies designed to stretch limited transportation dollars and enhance the flexibility of Federal-aid highway funds. The TE-045 initiative has generated substantial benefits in terms of building more projects with fewer Federal dollars and accelerating project construction. Many of the innovations tested were subsequently approved for general use through administration action or legislative changes made under the National Highway System Designation (NHS) Act of 1995 and the Transportation Equity Act for the 21^st Century (TEA-21).

The NHS Act was the next significant milestone in the evolution of innovative finance. The Act enabled a number of innovations:

• Established a State Infrastructure Bank (SIB) Pilot Program, originally available to a maximum of 10 states, but which was expanded to 38 states and Puerto Rico under the 1997 U.S. DOT Appropriations Act;
  
  
• Expanded the Federal matching share available for Federally-assisted toll projects;
  
  
• Authorized the use of Federal aid for debt instrument financing;
  
  
• Allowed loans of Federal aid to non-toll projects; and
  
  
• Made private donations eligible to satisfy non-Federal matching requirements.

The inclusion in the NHS Act of provisions to reimburse states for eligible debt-related costs and added flexibility related to advance construction gave rise to the new mecha-nism referred to as Grant Anticipation Revenue Vehicles (GARVEEs), sometimes referred to as Grant Anticipation Notes or GANs. Further expanding advance construction flexi-bility, a July 15, 1995 Federal Register notice implemented partial conversion of advance construction, which allowed states to convert an advance constructed project to a Federal-aid project in stages rather than all at once.

TEA-21 was passed in 1998, enacting the Transportation Infrastructure Finance and Innovation Act (TIFIA) to provide up to $10.6 billion in credit assistance to major projects of national significance. While TIFIA is the major finance innovation provided under TEA-21, the legislation also continued the SIB pilot program, although limiting Federal capitalization opportunities to only four states, and provided additional flexibility in non-Federal matching share requirements.

While ISTEA, Executive Order 12893, the TE-045 initiative, the NHS Act, and TEA-21 are generally recognized as the major administrative and legislative milestones in the evolu-tion of Federal innovations in financing strategies, one of the most important - yet least recognized - aspects of the innovative finance effort has been the ongoing Federal effort to provide a forum for discussion about new financing mechanisms and an incubator for their development. Through new publications, conference sponsorships, and myriad roundtable discussions, the Federal efforts have sought to solicit new concepts, dissemi-nate information on how recent innovations can be applied to real-world financing dilemmas, and help project sponsors and other participants in the transportation financing community accurately assess the risks and opportunities central to use of the resulting financing strategies.

1.4 Organization of Report

This report reviews the performance of U.S. DOT/FHWA's innovative finance initiatives, from TE-045 through the TIFIA Federal credit program. Chapter 2.0 describes the approaches used to measure the performance of these initiatives, which involve both quantitative and qualitative methodologies. Chapter 3.0 presents the quantitative results of the performance review, in terms of the ability of the innovative finance tools to leverage transportation investment, accelerate projects, and yield economic benefits. Chapter 4.0 contains case studies of 11 projects that have used one or a combination of innovative finance tools to overcome a project funding challenge. Finally, Chapter 5.0 offers observations and conclusions on the effectiveness of U.S. DOT/FHWA-sponsored innovative finance initiatives, and suggests ways in which continued experimentation with new tools could afford additional benefits for the nation's surface transportation system. Appendices containing data elements included in the project inventory, selected resources for additional information on innovative finance, and a glossary of terms are provided at the end of this report.