TE-045 Evaluation - Origins and Objectives

Since 1994, the Federal Highway Administration (FHWA) has been spearheading an initiative designed to cultivate new financial flexibilities within the Federal-aid highway program. Using a test and evaluation research initiative known as TE-045, the agency has solicited State proposals for alternatives to conventional pay-as-you-go, grant-based funding strategies. FHWA's overriding objectives throughout this process have been to increase investment, accelerate projects, improve the utility of existing financing mechanisms, and lay the groundwork for long-term programmatic and legislative changes.

This chapter reviews the history of TE-045 and outlines the objectives of the initiative. The chapter describes the eight principal financing concepts that have been tested over the past two years, and illustrates how TE-045 permitted more flexible use of key features of the conventional Federal-aid program. This comparison of conventional versus innovative interpretations of rules governing the Federal-aid highway program provides essential background to the remainder of this report.

Since its inception in 1916, the Federal-aid highway program's financial cornerstone has been a funding strategy known as grant reimbursement. Under this approach, FHWA reimburses State capital expenditures on highway infrastructure at a prescribed rate (historically, 80 or 90 percent), with the remainder of project costs being covered by the State. While the conventional Federal-aid program has enabled construction of an extensive Federal-aid highway system, including the nation's 40,000 mile Interstate system, the program's financial limitations are becoming evident in the face of the dual challenge of growing investment needs and shrinking availability of public funding to meet those needs. Within this context, strict adherence to the reimbursable grant strategy may no longer be the most productive approach; as noted by the Deputy Federal Highway Administrator, this single strategy is limited in range, slow to change, and not sufficiently productive to meet growing investment needs.

In recognition of the limitations embedded in the standard Federal-aid program, for the past three years FHWA has systematically revisited the on-going rationale for some of the more restrictive funding rules. Under this effort, FHWA has also sought to develop mechanisms to permit more flexible treatment of grant funds, expand the use of debt financing, and increase reliance on private sector investment. An important catalyst to this effort was President Clinton's Executive Order 12893, issued in January 1994, which established infrastructure investment as a priority for the Administration. The Executive Order also directed Federal agencies to establish programs for more effective investment from current Federal funds.

In response to Executive Order 12893 and in recognition of the need to explore new financing strategies, FHWA announced the Innovative Finance Program - Test and Evaluation Project (TE-045) in a Federal Register notice dated April 8, 1994. The program was established using statutory authority granted under Section 307(a) of Title 23 of the U.S. Code. Section 307(a) permits FHWA to engage in a wide range of research projects, including those related to highway finance. As part of this research effort, FHWA was able to waive selected policies and procedures so that specific transportation projects could be advanced through the use of non-traditional financing concepts.

TE-045 was initially designed and subsequently operated to give States a forum in which to propose and test those concepts that best met their needs. Projects advanced under TE-045 were thus identified by State-level decision makers facing real world barriers to financing needed transportation improvements. Since TE-045 did not make new money available, its primary focus and ultimate measure of success has been its ability to foster the identification and implementation of new, flexible strategies to overcome fiscal, institutional, and administrative obstacles faced in funding transportation projects.

Although TE-045 has been essentially a State-driven initiative, the April 1994 Federal Register notice identified several areas for States to consider when developing their project proposals, including:

On the basis of these guidelines and their own observations, the States proposed a range of new approaches to everything from matching strategies to the eligible uses of Federal-aid funds. In a few cases, the proposals extended too far beyond Title 23 requirements to permit FHWA approval of the projects. In most cases, however, FHWA staff were able to work with their State counterparts to refine concepts to a point where they were able to be tested.

All proposals were submitted by State departments of transportation (DOTs). The proposals tended to stop short of full-fledged privatization strategies, although a number of proposals involved some measure of private participation in funding the projects. For these projects, States concentrated on strategies that blended private contributions into the broader mix of funds directed to an individual project. In a few cases, States also proposed financing strategies that sought greater private involvement in issuing debt.

In recent years, the drawbacks of some of the Federal-aid highway program's more restrictive funding rules have manifested themselves in a variety of ways. First, States were required to set aside obligational authority equal to the entire Federal share of the cost of a project in the first year of project construction -- even if the project were actually to be constructed over several years. (An obligation is a prospective commitment of the Federal government to reimburse the Federal share of States' expenditures on eligible project costs. Obligational authority refers to the maximum amount of Federal funding that may be obligated in a given time period (usually a year). Levels of obligation authority are determined by Congressionally-established obligation limitations. Each State receives its share of total obligational authority on the basis of its relative share of total authorized funding distributed to all States for the given fiscal year.) This requirement had the unintended effect of forcing States to pursue multiple projects sequentially, rather than simultaneously. Second, strict adherence to the policy of reimbursable grants tended to encourage pay-as-you-go grant funding methods over leveraging techniques such as debt financing, even in cases where a pay-as-you-use strategy made good economic and financial sense. Third, the program generally acknowledged only Federal and State governments as financial participants in highway investment; public-private ventures remained a largely foreign concept.

The combined effect of these funding rules resulted in some projects being unnecessarily delayed and in Federal funds remaining almost wholly unleveraged on the capital markets. The broad objectives of TE-045, as shown in Table 1.1, responded directly to these concerns. In addition, TE-045 supported strategies to make existing opportunities more useful and to pave the way for long-range adjustments to the fundamental structure of the Federal-aid program. Together these objectives address many of the limitations and obstacles inherent in traditional highway financing methods.

Objective	Obstacle faced	TE-045 goals
Increase investment	Federal, State and local budgets are constrained; needs far outweigh resources.	Assist States in their efforts to leverage their current spending to attract additional capital, both non-Federal public and private.
Accelerate projects	States' commitment of funds for individual projects is governed by rules that can compel projects to be deferred for a number of years; certain matching restrictions can also delay project delivery.	Move projects into construction more quickly than under traditional financing procedures.
Promote use of ISTEA financial provisions	New and complex financing issues have challenged States' abilities to use existing flexibilities allowed under ISTEA, specifically under Sections 1012 and 1044.	Create incentives for States to take full advantage of ISTEA financing opportunities by allowing more flexible interpretations of these Sections.
Establish basis for future legislation	A knowledge gap exists regarding which financing strategies are practical, useful, and reproducible.	Accumulate a record of experience with new financial strategies. Use the experience to assist in framing new legislation and administrative rules.

Based on the initial concepts outlined in the April 1994 Federal Register notice and the financing techniques suggested by the States in their project proposals, a consensus set of eight innovative financing tools has emerged. These tools fall into two main categories: investment tools (also referred to as leveraging tools) and cash flow tools. Previous FHWA publications offer inventories and overviews of the financing mechanisms tested under TE-045. (For example, see Rebuilding America: Partnership for Investment, December 1994, Publication No. FHWA-PL-95-023.) A brief synopsis of these two groups of tools follows. An additional funding strategy known as Surface Transportation Program (STP) Simplification is also being tested under TE-045 and is described in the following section.

Investment tools generally seek to increase the total amount of resources available for transportation projects, given budgetary limitations on Federal investment. As noted above, investment tools are often referred to as leveraging tools because by attracting additional sources of funds (both public and private), they seek to expand (leverage) the purchasing power of existing State and Federal funds dedicated to transportation improvements. The four principal investment tools are:

Cash flow tools seek to move projects to construction sooner, often by permitting States to take on more projects simultaneously. These techniques typically provide flexibility in the rules that govern States' obligation of Federal-aid funds and the subsequent reimbursement of State expenditures. In doing so, they can help States manage their annual highway construction and maintenance programs more efficiently. In addition, these tools generate real economic returns by bringing the benefits associated with individual projects on line sooner. The four principal cash flow tools tested under TE-045 are:

It should be noted that of these four cash flow tools, phased funding is no longer being tested. Tapered match continues to be tested, but only on an experimental basis.

STP Simplification is a recent addition to the set of tools being tested under TE-045. It refers to a pilot program under which a State may bundle together numerous STP-eligible projects and subsequently commit Federal funds to those projects in a single obligation. In addition, States are permitted to maintain Federal-State matching ratios across the full program, rather than on a project-by-project basis. The idea behind streamlining the program in this fashion is to help States manage their Federal-aid highway money more efficiently and to move projects to construction more rapidly. While the anticipated three pilots being tested depart, strictly speaking, from the project-specific approach followed within the rest of the TE-045 program, STP Simplification nonetheless targets similar objectives.

To ground the discussion of the results of the TE-045 initiative, Table 1.2, displayed on the two following pages, summarizes the principal financing tools tested under the initiative. The table indicates the impact of TE-045 financing concepts on funding practices that typified the Federal-aid program prior to creation of TE-045.

It should be noted that certain approaches tested under TE-045 have evolved to a point where they have gained statutory approval under the National Highway System (NHS) Designation Act of 1995 or through administrative action. Accordingly, Table 1.2 also indicates, as appropriate, instances where the experimental approach tested under TE-045 can now be considered "conventional," given recent statutory and administrative changes.

Table 1.2: Impacts of TE-045 Financing Concepts on Aspects of the Conventional Federal-Aid Highway Program

	Conventional Federal-Aid Program	TE-045 Financing Innovation
Flexible Match*	Private and certain local contributions to highway projects come off the top of total project cost, with the standard Federal-State matching ratio (usually 80%-20%) being maintained on the balance of project costs. This means that the State must still provide matching funds no matter how large the contribution by the private entity.	The value of private and certain local contributions directly offsets the State share. As a result, it is possible for a private contribution to entirely satisfy the non-Federal matching requirement. Because the benefits of private contributions accrue wholly to the State, flexible match can increase a State's incentive to actively seek private partners.
Section 129 Loans*	Section 1012(a) of ISTEA amended Section 129 of Title 23 of the U.S. Code to permit States to obtain Federal reimbursement for loans they make to toll projects. ISTEA Section 1012 placed restrictions on the terms of the loans and eligible uses of loan repayments.	States may initiate reimbursable loans to any project with a dedicated revenue stream (i.e., not necessarily tolls). Other flexibilities related to loan terms and institutional arrangements also expand the utility of Section 129 loans.
ISTEA Section 1044 Toll Credits*	Section 1044 of ISTEA permits States to apply the value of certain highway expenditures funded with toll revenues toward the required State match on current Federal-aid projects. States may only substitute toll credits for State match if they demonstrate a "maintenance of effort" (MOE). The MOE test requires that a State's prior-year highway spending equaled or exceeded the average of the previous three years' expenditures.	The MOE requirement is relaxed such that States may offset State match with Section 1044 toll credits so long as they meet the test prospectively -- e.g., anticipated current-year expenditures meet an average of the three previous years' expenditure levels. States may elect to have the MOE test extend as much as one year into the future. In addition, credits earned in prior years no longer lapse.
Reimbursement of Bond Financing Costs*	Federal-aid funds may be used to reimburse the cost of retiring the principal component of project debt for certain projects. Interest, issuance, and administrative costs are not eligible for Federal reimbursement, except for interest costs on Interstate construction projects.	Interest, issuance, and administrative costs are now eligible for reimbursement, in additional to principal payments.
Post-ISTEA Advance Construction*	Under advance construction States may use State and local funds to construct projects while still preserving those projects' eligibility for future Federal-aid reimbursement. However, all conversions to Federal-aid must be made by the end of the ISTEA authorization period.	Reimbursement of advance construction expenditures may extend into the next authorization period, assuming that Federal-aid apportionments continue beyond the end of the ISTEA authorization period. States must limit their use of advance construction to their unobligated balance of apportioned funding and three years of anticipated funding.
Partial Conversion of Advance Construction*	When projects are converted from advance construction, a State DOT must obligate the entire cost of the project at once, regardless of the expected pattern of actual expenditures and resulting Federal reimbursement.	States may obligate funds for advance construction projects in a phased fashion, such that amounts obligated approximate the amounts actually expended. No Federal funds are committed until their obligation.
Phased Funding	States must obligate the entire cost of a project all at once, regardless of how many years it will take for the project to the project to be constructed and thus translate into expenditures.	States may obligate funds over time, such that amounts obligated approximate the amounts actually expended. Federal funds are committed to the project, subject to availability of contract authority.
Tapered Match	A standard matching ratio must be maintained throughout the life of a project's construction. Every voucher a State submits for Federal reimbursement must be limited to a set percentage (usually 80 percent) of the actual expenses incurred by the State.	The matching ratio is permitted to vary over time. Federal reimbursement of State expenditures can be as high as 100% in the early phases of a project, so long as by the time the project is complete, the overall Federal contribution does not exceed the Federal-aid limit.
STP Simplification	All individual Federal-aid projects must be approved, administered, and tracked separately.	States may bundle together individual projects to be funded through the Surface Transportation Program. In this way, numerous projects may be treated as a single project for the purposes of approval and administration.

*As further discussed in Chapter 5 of this report, asterisked financing techniques have now been approved as standard features of the Federal-aid program, either by law (NHS Designation Act of 1995) or by administrative action. In some cases, statutory treatment of the tools differed slightly from the concept tested under TE-045. For example, for flexible match, certain public donations of funds, materials, or assets must still be deducted from the entire project cost rather than applied to the State share of project costs. Chapter 5 also details the status of the three strategies that have not been approved.

The principal financing concepts pioneered under TE-045 have produced significant quantitative and qualitative benefits that align closely with the initiative's four principal objectives. The initiative's quantitative benefits have been realized in two primary categories: first, in increasing investment levels, and second, in accelerating project delivery. In general, investment tools such as flexible match and Section 129 loans have played the greatest role in attracting new sources of capital to transportation projects, although certain tools (e.g., ISTEA section 1044 toll credits) have ultimately proven at least as effective in helping States administer their programs as in increasing investment levels. Cash flow tools, such as partial conversion of advance construction, have offered the primary benefit of accelerating projects by permitting States to alter the timing and/or administration of Federal funds to better match project timetables. At the same time, the benefits associated with investment and cash flow tools are not mutually exclusive, as powerful synergies have resulted in several instances where States have combined investment and cash flow tools on a single project.

TE-045's qualitative benefits are also apparent in two dimensions: first, in improving the utility of certain financial provisions of the Federal-aid program that pre-dated the TE-045 initiative, and second, in laying the groundwork for ongoing statutory and regulatory improvements to the Federal-aid highway program. The initiative's accomplishments to date in improving the utility of existing financial provisions primarily derive from efforts to broaden the terms of certain financial provisions introduced by ISTEA. TE-045's role to date in supporting additional long-term changes to the Federal-aid highway program is principally evident in the financial provisions of the NHS Designation Act of 1995 and two recent administrative changes.

Looking ahead, TE-045 continues to be an incubator for new approaches to financing Federal-aid highways. FHWA is continuing to accept proposals for newly identified financing concepts on a rolling basis. This process, coupled with continued consideration of the lessons inherent in the TE-045 experience to date, will build on the benefits already realized under TE-045. The process will also help set the agenda for future research and potential future legislative and administrative action.