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Chapter 5 - Legislative
and Regulatory Implications of TE-045
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As seen in the two preceding chapters, by increasing transportation investment levels and accelerating projects, TE-045 has produced immediate measurable benefits to State participants in accordance with the first two objectives set forth for the initiative. The third and fourth objectives for the initiative centered on:
- facilitating States' use of financing tools introduced under ISTEA; and
- providing experience to lay the groundwork for long-term programmatic and statutory changes to the Federal-aid program.
TE-045 has facilitated the States' use of ISTEA financing tools to varying degrees, as certain features of the Federal-aid program have been made significantly more attractive through flexibilities offered under TE-045, while States' interest in other program features has remained muted. TE-045's final objective has been partially realized through recent administrative actions and, more notably, congressional enactment of the NHS Designation Act of 1995. While TE-045's programmatic effects often receive less attention than its quantitative outcomes in supporting increased investment and project acceleration, the initiative's support for fundamental changes to the Federal-aid program merits special attention given that these policy impacts were largely influenced by an initiative that offered no new Federal funding.
This chapter considers TE-045's role in addressing these final objectives of the TE-045 initiative. The chapter also recaps the initiative's influence on the financial provisions incorporated in the NHS Designation Act of 1995 and recent administrative actions.
Effects of TE-045 on the Utility of ISTEA and Other Financing Options
Among its financial provisions, ISTEA included two innovations -- Section 1012(a) and Section 1044 -- that introduced two new financing concepts into the Federal-aid program. As noted in Chapter 1, ISTEA Section 1012 amended Section 129 of Title 23 of the U.S. Code to permit States to use Federal-aid funds to reimburse State-initiated loans, rather than grants, to eligible projects. ISTEA Section 1044 permitted certain expenditures funded with toll receipts to substitute for the State matching share on future Federal-aid projects. Restrictions written into the relevant legislative sections tended to limit the utility of these provisions to the States. By offering opportunities to broaden the terms of Section 129 loans and ISTEA Section 1044 toll credits, TE-045 has supported somewhat greater utilization of these and other financial provisions of the Federal-aid program.
SECTION 129 LOANS
Although States' use of Section 129 loans still falls short of the expectations that accompanied enactment of Section 1012 of ISTEA, TE-045 has nonetheless played a significant role in improving the utility of this financing concept. Prior to the introduction of TE-045, no State had implemented a Section 129 loan, although several States were working to identify ways to develop viable loan agreements. TE-045 offered the necessary means to make Section 129 loans a reality, and currently, five projects that are using or contemplating Section 129 loans are advancing under the auspices of TE-045.
Under TE-045, several States sought greater latitude in the conditions under which they could offer Section 129 loans to project sponsors, including private entities. For example, under TE-045, States gained the opportunity to make loans to projects with revenue streams comprised of diverse income sources, such as lift fees at intermodal facilities. Previously, under ISTEA alone, States could only offer loans to toll projects. In addition, Section 1012 of ISTEA was prescriptive with respect to the terms of loan provisions, and limited the eligible uses of loan repayments. Finally, Section 1012 required that a State DOT originate the first flow of cash by initiating a loan, and only thereafter obtain Federal-aid reimbursement.
TE-045 offered States opportunities to step beyond certain of these restrictions in a controlled and supervised fashion, with the result being two executed loans and three pending loans that are consistent with the legislation's original intent. In Ohio, for example, the opportunity to provide a Section 129 loan to a non-toll project enabled a $13 million loan to an intermodal facility. The function of the facility does not lend itself to traditional tolls, but trailer lift fees will provide an alternate income stream. In New York, a consortium of local governments is exploring the possibility of directly lending Federal-aid funds to a series of projects rather than using Federal-aid funds as a reimbursement for State-initiated loans. As with other Section 129 loans, loan repayments could ultimately capitalize a revolving loan fund. Implementation of this State program is pending action by New York's State Assembly on necessary enabling legislation.
Even though TE-045 has prompted greater use of loans (an increase from zero to five), most States still appear reluctant to use limited obligational authority to fund loans rather than grants. States' continued hesitancy with respect to Section 129 loans warrants some special consideration, particularly given the fact that these loans can be viewed as an important bellwether for the anticipated operations of State infrastructure banks, which represent an important new transportation financing initiative currently being tested by ten States on a pilot basis. Also, loans merit special attention because of their significant untapped potential for stretching public funds.
On the basis of observations offered by State officials throughout the country and a variety of other transportation experts, it appears that at least five factors have limited the potential appeal of Federally-reimbursable project loans.
- A significant obstacle to States' use of Section 129 loans is the fact that when States obtain Federal reimbursement of Section 129 loans, the action consumes a portion of their annual obligational authority. In many cases, States program most or all of their obligational authority several years in advance under the State planning process, leaving little or no room for new commitments of that obligational authority. As the practical mechanisms for making Section 129 loans become better understood and their potential benefits more fully recognized and documented, it is reasonable to expect that more States will explore the benefits of programming future obligational authority with an eye to Section 129 loans. In addition, using a loan in conjunction with partial conversion of advance construction can reduce the amount of obligational authoirty that is consumed in any one fiscal year. Partial conversion effects this outcome by spreading the obligation of Federal funds over several years. In the near term, however, most States appear reluctant to disrupt current plans by re-programming obligational authority or converting grant-funded projects into loan-financed projects.
- The use of a loan requires that the recipient project have a source of revenue with which to repay principal and interest on the loan. While TE-045 expanded eligible revenue streams beyond tolls, a number of States still appear unable to identify projects that could generate a dedicated income stream. Part of the inability to identify such projects is linked to widespread public opposition to new tolls, taxes, and fees. Attempts to re-program the use of existing receipts can also prove impractical, since redistributing a fixed sum of revenues always implies that some projects gain at the expense of others.
- Another factor that limits a number of States' interest in project loans is the presence of State-specific legal or constitutional prohibitions on State provision of loans to developers or other public or private partners.
- Loans represent new and unfamiliar territory for many States. Although loans were introduced almost five years ago through Section 1012 of ISTEA, FHWA has concentrated most of its publicity for the concept within the TE-045 initiative. It is likely that something beyond the two-year experience with the TE-045 initiative will be needed before a large number of States gain a full understanding of the concept and are able to identify satisfactory candidate projects.
- Loans are usually most applicable to large, complex projects that typically have a multi-year gestation period, regardless of their selected financing method.
SECTION 1044 TOLL CREDITS
Section 1044 of ISTEA permitted States to substitute certain previous toll-financed investments for State matching funds on current Federal-aid projects. To a very limited extent, flexibilities pioneered under TE-045 facilitated States' use of Section 1044 toll credits. Since the passage of ISTEA, a total of thirteen States (which includes Puerto Rico) have earned over $3.0 billion in 1044 investment credits as of August 1996. Of these thirteen States, ten States had applied a total of $853 million worth of credits as of September 30, 1995 to actual projects.(FHWA surveys states regarding the use of already accrued investment credits every other year. The most recent FHWA survey data available regarding the use of toll credits are as of the end of fiscal year 1995 (September 30, 1995).)
Of these thirteen States, only two States -- Maryland and Michigan -- have explored more flexible interpretations of Section 1044 under TE-045 by proposing relaxation of the MOE requirements spelled out in ISTEA. In Maryland's case, credits that were earned in fiscal year 1992, but remained un-used could now be accessed since the State was able to meet the more relaxed MOE requirements. Michigan was a newcomer to the 1044 program, earning an initial $13.7 million in 1044 investment credits in FY 1994. Michigan was able to utilize the more flexible MOE provisions allowed under TE-045 and apply a portion of these credits as soft match for various capital improvement projects.
Although 1044 has not met its primary goal of effecting a net increase in transportation investment, officials from States that have used the credits still regard Section 1044 as advantageous. State officials in Maryland indicate that use of toll credits has helped the State better manage its cash flows. For example, Section 1044 credits may be used when current cash is not available to meet the non-Federal match requirements. In Florida, use of 1044 credits is viewed as a useful planning and management tool and has helped the State gain expanded access to Federal funds in certain categories. Although Florida has not employed one of the new, prospective MOE determination methods, one State transportation planner indicated that the increased flexibility now afforded under recent FHWA guidance will improve the value of Section 1044 credits as a planning tool. Under the retrospective MOE test, if a State failed the test, the State could not use Section 1044 toll investment credits and would have to reformulate its future plans to use the credits before they lapsed.(Under the retrospective MOE test, a State has four fiscal years to use its earned credits. Those four years include the fiscal year for which the credit was established plus the following three fiscal years. Under the new prospective MOE test, earned credits do not lapse.) The new alternate methods of determining compliance with the MOE reduce this uncertainty when developing future transportation financing plans using 1044 credits.
OTHER PROGRAMMATIC ELEMENTS
Although TE-045 directly aimed to promote use of financing concepts incorporated in ISTEA, tools tested under the initiative have also sought to promote use of two pre-existing elements of the Federal-aid highway program: advance construction and reimbursement of certain bond financing costs. Among these two programmatic elements, TE-045 has generated a more prominent impact on States' use of advance construction. Advance construction has been part of the Federal-aid highway program since 1956, and permits States to construct projects with their own funds while still preserving those expenditures' eligibility for Federal-aid reimbursement at a later date. Prior to TE-045, the utility of advance construction was dwindling, as States could not convert projects to Federal-aid after the final year of ISTEA (i.e., the end of Federal fiscal year 1997). TE-045 created an opportunity for States to access advance construction after the end of the ISTEA authorization period. This innovation proved of substantial benefit to the eight States that are committing State funds to advance construction projects that will not be converted to Federal-aid until after the start of the next authorization period. Partial conversion of advance construction also improved the utility of advance construction, with 17 States using this tool between April 1994 and July 1996.
Repayment of bond principal has been eligible for Federal reimbursement since 1956. Several proposals under TE-045 sought to improve the utility of Federal reimbursement of bond financing costs by expanding the range of costs eligible for reimbursement. These new flexibilities pioneered under TE-045 and subsequently authorized under the NHS Designation Act have had only a moderate impact on States' use of this eligible use of Federal-aid funds. To date, States have proposed to use the bond reimbursement technique on only two of the seven TE-045 projects that include bond issues.
In general, States' minimal use of Federal-aid to cover the costs of debt issues (or more typically, to reimburse some of the costs of another public entity or private entity issuing debt) stems from many of the same impediments that limit States' interest in using loans to facilitate debt financings. First, the fact that reimbursing bond financing costs consumes an equivalent portion of obligational authority presents a significant impediment to use of this tool; many State officials are reluctant to use limited obligational authority for this purpose when pay-as-you-go grant strategies are so much more familiar. Second, the complexity of debt financing generally, and of Federal reimbursement of bond financing costs specifically, suggest that State DOTs still need time to identify reasonable project candidates and to find strategies to maximize the efficacy of this newly eligible use for Federal-aid funds. Third, some States have a philosophical aversion to issuing debt, which in some cases is manifested by legal constraints on State DOTs' ability to issue debt or to reimburse another entity for its cost of bond financing. A final impediment to broad use of Federal reimbursement of bond financing costs is the fact that this financing strategy is still largely untested, and market reaction to bond issues to be repaid with Federal-aid is still untested.
Even so, the potential applications of this tool, now broadly available under Section 311 of the NHS Designation Act and codified under Section 122 of Title 23, are currently being explored by practitioners in the field of public finance. The Act specifies that Section 122 does not offer a Federal guarantee of the bond issue that will employ this technique, and under current law, the presence of such a guarantee could jeopardize the tax-exempt status of the affected bond issue.
Even without a Federal guarantee, Section 122 creates opportunities for States to incorporate this strategy in their financial plans. The two applications that may emerge include: (i) use of Section 122 in conjunction with the issuance of short term debt obligations called grant anticipation notes (GANS) and (ii) use of Section 122 to provide an alternate source of repayment for long term debt obligations. Neither of these methods has been tested, but State DOTs and their advisors are working to identify and balance the concerns of investors and rating agencies in order to employ these techniques.
One issue that must be faced in combining the provisions of Section 122 and a bond issue is the willingness of issuers, investors, and rating agencies to view future Federal-aid apportionments as a reasonably reliable source of repayment, capable of receiving investment grade ratings and market acceptance. Since this approach is new, attention will have to be given to explaining the Federal aid process to these parties and building their confidence in the future availability of funds in spite of the political influence on federal policy. Bonds which pledge dual sources of repayment may be more feasible initially as these techniques are tested. Offering a familiar, commonly creditworthy revenue stream such as gas tax, sales tax, or toll revenues as the primary source of repayment with the Federal revenue stream acting as the secondary source of repayment may help introduce and open the bond market to further integration of the bond reimbursement technique and debt financings.
Influence on the NHS Designation Act and Recent Regulatory Changes
In keeping with the original objectives of TE-045, States' experiences under the test and evaluation initiative have formed a foundation for subsequent legislative and regulatory actions. TE-045's lessons have primarily been embodied in the financial provisions of the NHS Designation Act of 1995. The Act amended Title 23 of the U.S. Code to institutionalize four distinct approaches tested under TE-045. In addition, administrative changes, one of which was announced through the Federal Register and another through policy guidance, have institutionalized further adjustments to the Federal-aid highway program. As a result, six new financing approaches, yielding six new forms of financial flexibility, are now available for States' general use outside of TE-045. Table 5.1 illustrates the evolving status of the individual tools tested to date under TE-045.
Table 5.1: Legislative and Administrative Status of Innovative Financing Tools as of July 1996
Innovative finance tools tested under TE-045 Included in NHS Designation Act (November 1995)
Implemented administratively (1995-1996)
Still experimental No longer being tested Flexible Match X . . . Bond Reimbursement (principal, interest, issuance, and insurance costs) X . . . Section 129 loans X . . . ISTEA Section 1044 Toll Investment Credits . X . . Post-ISTEA Advance Construction X . . . Partial Conversion of Advance Construction . X . . Phased Funding . . . X Tapered Match . . X . STP Simplification . . X . As indicated in the preceding table, two cash flow tools tested under TE-045 -- phased funding and tapered match -- were not authorized under the NHS Designation Act. Congressional concerns regarding phased funding centered on two primary issues. First was the concern that by prospectively committing future obligational authority through use of phased funding, States could potentially fall short of funding in later years. There is no evidence to date that phased funding is causing States to overextend themselves in this fashion; State officials contacted for this report indicated that they are fully aware of the potential consequences of staged obligation of project costs and recognize that it is their responsibility not to overprogram future years' obligational authority. Continued experimentation with partial conversion of advance construction will illustrate States' capacity to monitor the implications of their programming decisions.
A secondary concern related to phased funding centered on the fact that when obligations are spread out over time to mirror the trajectory of actual expenditures, every dollar obligated translates into a dollar expended in the same year. While this spending pattern makes sense from a State perspective, it is out of step with Federal expectations that something considerably less than a dollar is actually expended in the year of obligation.(The Office of Management and Budget and the Congressional Budget Office assume for budgetary purposes that across the Federal-aid program, every dollar obligated in a given year on average translates into expenditures of about 15 cents during the first year (i.e., the year of obligation), 53 cents during the second year, and 16 cents during the third year, with the remaining 16 cents spread over the next six years.) Since Congressional appropriators set annual obligation limitations on the basis of anticipated expenditures (or outlays) during the coming fiscal year, an acceleration in the so-called outlay rate could cause actual expenditures to outstrip expected levels, marginally worsening the Federal budget deficit for the year in question. While a similar argument can be made with regard to partial conversion of advance construction, certain practical and legal limitations on how much of a given State's capital program may be advance constructed will place some checks on the extent to which partial conversion of advance construction is used. These checks would in turn restrict the financing concept's ultimate impact on the national outlay rate. Over time, continued use of partial conversion will help build a track record that illustrates the extent to which staged obligations will effect noticeable shifts in the aggregate pattern of expenditures.
Congressional concerns with tapered match revolved around the concern that relieving States of the responsibility for covering a share of project costs during the early years of construction would have the unintended effect of removing States' incentive to aggressively control project costs. Some State officials also voice concerns about tapered match, noting that this strategy can impose an administrative burden by requiring administrators and accountants to track multi-year, project-specific matching ratios to ensure that over the life of a project, the ultimate Federal share does not exceed the Federal-aid limit.
Program-level match is one strategy that could enforce States' accountability for completion of individual projects while also responding to States' concerns as to the administrative burden of tapering. Under program-level match, States would be required to maintain a standard matching ratio across all annual spending under a given funding category (e.g., the Surface Transportation Program or the National Highway System). In this way, matching ratios would apply to groups of projects rather than to each and every project. The concept of program-level match, as well as other financing concepts that may merit continued research, are more fully explored in the following chapter.
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 an evaluation of the te-045 innovative finnance research initiative prepared for the u.s. federal highway administration |
