Financing Tomorrow's Infrastructure: Challenges and Issues: Proceedings of a Colloquium (1996)

Bruce D. McDowell

Government Policy Research

I used to give speeches called "How to Improve Public Works with No New Money." They were very creative speeches. But the kind of speech you have to give now is, "Public Works Improvements with even Less Money Than You Thought You Had."

Fellow panel chair Nancy Rutledge Connery and I worked together on the National Council on Public Works Improvement. The problem with the council's report was that it came out right at the end of the Reagan administration and was passed along to a new administration, which, for one reason or another, did not pick it up. President Clinton gave it a whirl with his investment program, and it went down in flames. It was not quite the right time, but the right time is coming.

I had the task at the Advisory Commission on Intergovernmental Relations of bringing together people intergovernmentally and across the agencies of government to discuss what a federal infrastructure strategy should look like. One task force looked at how you do finance in constrained situations. The basic conclusion was that in any kind of infrastructure planning you need a financial planning element from the very beginning. We published the results in November 1993 as, "High Performance Public Works: A New Federal Infrastructure Investment Strategy for America."

We see an example of this financial planning now in the Intermodal Surface Transportation Efficiency Act (ISTEA), which requires that all transportation plans at the state and metropolitan level be done in a financially constrained fashion. State and metropolitan planning organizations are beginning to hire financial analysts to get the job done along with the rest of the planning process. Our four panelists will offer observations on how financing is affecting the provision of infrastructure today and how it will continue to do so in the future.

Charles E. Williams, Major General (retired)

Rebuild Incorporated

I feel very fortunate to be standing here, not only for those who sponsored the Dulles Greenway but also for our nation, the state of Virginia, and everyone included in this colloquium because the Dulles Greenway is the first of its kind in more than 100 years in Virginia. I do not know how that shakes out around the country, but it has been a long time since we have had a completely delivered, privately owned toll road.

The story of the Dulles Greenway is a very long one, and I will spare you the story prior to my arrival. September 29, 1993, is the day we broke ground. The Dulles Toll Road runs about 13 miles from the Beltway, 1495 west to Dulles airport. The road we just opened, called the Dulles Greenway, is 14.1 miles long, going from the Dulles airport west to the historical town of Leesburg, Virginia.

One of the things we learned early on about a successful toll road is that the road has to leave one rather significant point and connect to another one. In our case, it leaves from Dulles airport, which is the airport with the greatest capacity to expand on the East Coast and has a $2 billion capital program ongoing. So it made a lot of strategic sense to connect a road to that significant facility. Beyond that, the Dulles area is a dynamic area for a lot of reasons. The Air and Space Museum is moving to that vicinity, so this also factored into some of the corporate thinking. We connect to Leesburg, which has historical significance and is growing. That was, overall, the fundamental strategy that went into the corporate planning on selecting the location for the road.

There was already a public need for an infrastructure facility of this type. Let us look at a couple of reasons. Number one, we needed to unload traffic off the lateral north roadway, which is Route 7, and the southern lateral of Route 50 and Interstate 66. At the same time, that particular portion of

the county offered the best opportunity for growth because in and around the Washington area the other corridors are approaching maximum development. Therefore, the Dulles corridor seemed to offer the best opportunity, as economists were telling us at the time. The strategy for locating the road on this footprint was two-pronged. One, it made good strategic sense from a planning standpoint. And two, it connected well to the economic growth pattern in that corridor. The point is, you do not locate a toll road, or any other facility to which you expect to have user fees attached, just any place. You must really think it through, not only in order to make good transportation and public sense, but also to match the economics.

There are two questions I think are very important, one for the public side and one for the private. We have really got to think about where we are going to be in the year 2020, and that is why this forum today is so important. The NRC is out front on the thought process. We have to think about the whole infrastructure question as it relates to transportation in the year 2020, because we simply cannot put facilities in place overnight. Delivery of private facilities is very difficult because they are linked to private financing. However, whether the financing comes from the public or private sector, it is still a very difficult business.

Virginia is very fortunate because a lot of money flows into its transportation coffers. The problem is that some of the $2 billion, in my opinion, is going into the wrong pots. For example, 45 percent of the transportation dollars are going toward new construction; that should be 75 percent, to my way of thinking. Therefore, the 40 percent going to maintenance, which drains the new dollars, quite frankly is too high. On the other hand, Virginia has a lot of transportation network that is obsolete and needs a tremendous amount of maintenance.

The way for the private sector to become a partner is to carve into the maintenance area with new construction and help reduce it to 20 percent, where, I believe, it should be. Then the private sector could take a whack at the inefficiencies in the 15 percent in operations by putting in smart highway operating techniques and reduce that to about 5 percent. Really, the transportation dollar should be broken out as 5 percent operations, 20 percent maintenance, and 75 percent new construction, if you were proportioned somewhat nearer the ideal.

Virginia has a lot of highways and as a result a big maintenance problem. The state will be spending $40 billion over the next 20 years. Virginia would still be unable to fulfill its total maintenance requirements. This is what drives the whole notion of enticing the private sector to come in and help with the problem because, regardless of which side of the aisle may be driving the political process, you cannot handle this $40 billion problem in the next 20

years without help. This is also why there are very good opportunities in the state of Virginia for private sector infrastructure projects.

These were some of the high hurdles that we had to get over. Securing equity sponsors was a big issue because, obviously, that was the first dollar spent, that was the high risk dollar. Equity sponsors are not easy to find because you are talking about soliciting an individual, a pension fund, a bank, or some financial institution to put money at risk and receive a no-book earning for quite some years. So, quite frankly, the sponsors are very selective. There are some out there, but you have to be very mindful that they are not easy to capture.

Local and state agreements are also very important. Environmental work, in my estimation, is at the top of the list of hurdles. You simply cannot finesse the environmental process. You operate with a deregulated mentality, but at the same time there are certain compliances that you must do because the whole concept of privatization is that you are borrowing a project from the public portfolio and moving it over into the private world for a period of time. You will privatize it, operate it like a private entity for a certain concession period, and then it goes back to the public. The responsible public entity, be it a state or a city or whatever, is the ultimate owner of that facility, so you cannot ever step completely away from the public arena.

Securing permits and engineering are self-explanatory, but it was very important to get the right contractor and that the contractor listen to the new drumbeat. Securing the financing was very difficult. Our project costs were about $326 million using three different types of money: a heavy equity slice; some construction-dollar funding, which we call short-term money; and some 30-year money, which obviously was of the long-term debt type. In addition to getting the sponsors, we had to cross two additional hurdles, to find a consortium of banks that would provide the short-term financing and long-term lenders who could stay the course for 30 years.

The endgame was simple. No one wants traffic tie ups, and no one wants more taxes. The only other option was tolls. We do not make any excuse for the toll rate because we are creating an option for the traveling public, not a demand. We have given people an alternative that is a "quality of life" enhancement. If time is important to the motorist, that must be factored into the decision to pay the toll.

In our case, there are parallel arteries running east and west of our roadway that will carry the traveling public from western Virginia and West Virginia into the Washington area, but they have more than 20 traffic lights. The model travel time on either of those arteries is about 1 hour and 15 minutes from Leesburg to Constitution Avenue in downtown D.C., varying about five minutes depending on whether you are coming from north or south. The model time for the Greenway now is about 40 minutes to Washington, D.C. The real

issue is whether you want to pay to save time or you would like to stay on the other arteries and fight the traffic.

This project, as I mentioned, was the first of its kind. It was fast paced and very expensive because we probably have a heavier slice of equity than we would like to see going forward. Because this was a pioneering effort, there were a lot of skeptics who questioned whether the concept was going to work; therefore, the equity requirements were a little bit higher.

There has been a lot of social/economic fallout over this project. We created more than 500 jobs in the region very quickly and quietly. You do not normally think of a privatization effort doing this sort of thing. We were able to attract blue chip lenders, the top of the line in terms of long-term lenders. This obviously made control and management critical. The schedule had to be made, and, of course, the public used this first project as an outdoor theater because it was something that they had not seen for some time.

We had everything that you could possibly have here in the way of challenges. We had to acquire the right of way for 14 miles. We had no condemnation authority per se. Not one acre, not one inch was condemned by the state. We actually purchased outright a third of the road from 47 different landowners, with individual negotiations to get a 250-foot swath across their property. The other third of the property right of way was obtained through a mutual type conveyance arrangement. The landowner was interested in developing, say, a large residential area, and it was convenient to have a road and an interchange at that location. In exchange for that, the landowner conveyed a portion of the property.

The eastern portion was on federal property. You cannot purchase federal property; you have to work out some other arrangement. We have a very long leasehold arrangement with the Metropolitan Washington Airport Authority, whereby we leased the 226-acre swath that we touched. In this part of the roadway, we impacted 64 acres of wetlands, so another critical job was to mitigate for the environmental impact. With the wetlands site, we had all of the problems of "not in my backyard." The regulatory process required us to do a two-for-one mitigation. We had to put in place about 126 acres with an assortment of plants and trees. The handling of the planting was very delicate. We increased that to 150 acres because, once we started looking at it, there were some enhancements required to make the site a truly class act. So we made it into an environmental show piece. It is being considered for use now by one of the major universities for science work and other conservation training. So these were the by-products.

I just want to mention one thing here about the general contractor and the way we worked this. All of you who have dealt with construction know about "retainage." Retainage is normally a portion or percent of the monthly draw that the owner holds for contingencies down the way. One of the

innovative spins we put on our deal was that we took the retainage up front from the contractor, and we took it from a source that was not cash. We took a letter of credit. So, during the execution we held a letter of credit from our contractor rather than retaining his cash. This was perceived as an incentive for the contractor because, if the contractor intended to do the job right in the first place, and the cash that was expected was not tampered with, this was obviously better for the company as a hold. This also put us in a better posture with the financing institution because we had our retainage up front. So when the project was presented to the financing institutions, we were able to show the letter of credit to answer the question of how to deal with some of the contingencies.

I think it was also important to manage peripheral talk normally facing the highway contractor. The traditional picture a contractor would normally be faced with is—build 14 miles of road, so many bridges, etc., and, oh, by the way, would be asked to do all of these other things as well, relocate the utilities, work the insurance out, do the wetlands, and handle the regulatory agencies. We had 176 permits associated with this project, which the contractor would have had to deal with. We worked with 17 regulatory bodies of different sorts—federal, state, county, and town—as well as other interested groups. What we did as the owner was to take all of the risk associated with this collateral work and manage those tasks ourselves. Now the contractor had a clear shot at the project. He had just the roadway to deal with. All of the tasks that would have created problems were pretty dismissed away for the contractor because the owner took those.

And then, of course, the last challenge is the organization of the team. Across the board, I might be the only person who has fully developed a project of this type from inception all the way through delivery. The Dulles Greenway was opened on its 24-month anniversary to the hour. We broke ground September 29, 1993, at 11 a.m., and we cut the ribbon September 29, 1995, at 11 a.m. It was six months ahead of schedule, and obviously that early completion potential was an incentive for the contractor.

A question was raised regarding operations and maintenance and whether that will also be privately funded. In the operation and maintenance section of the financing plan, we have reserves for overlay pavement. So the money is already in the financials. As to whether the private sector will be more efficient at maintaining highways, we are providing data on that very quickly now in an empirical way. I think even the state of Virginia will say, after a

period of time, that the techniques we used to put the facility in place will most likely reduce the maintenance requirements.

I will give you an example of some of the things we did. As most people who build these facilities know, there is a range of what you can do in compliance with specifications. We operated at the very top end of the specifications. For example, our roadbed required 12 inches of stone before the asphalt. We treated the second 6 inches with cement to make it stronger. We were within specification without cement, but we chose to treat it with cement. We know this will have a lasting effect and reduce the maintenance.

We have funding in our financial pro forma to overlay the road every seven years. We are hoping to get close to 10 years between repavings. We have a pavement-monitoring system whereby we do a lot of diagnostic work. So we will be getting a lot of intelligence about what is happening as we go along. That is how the maintenance will be reduced.

The Greenway has no public money at all. It is unique. It was not a public/private venture as you know it, where we had a portion of federal money and some matching amount from the state. This was all private money. I would maintain that this is not the way to do it, but we had to do it this way in order to break the first one through.

The Intermodal Surface Transportation Efficiency Act (ISTEA) came along about midway through our development. We were not able to utilize it, but we are clearly looking to it in the future. In a model sense, the way it should work would be through the flexibility ISTEA legislation creates for the states. The state of Virginia, hypothetically, would have to petition the federal government to allow certain allocated funding to Virginia to be used for a private venture. That is the way the ISTEA works, as I understand it. ISTEA comes with no money. This was a misnomer when it was suggested. When the bill passed, everybody went with their hands out saying, "Where's the money?" There was no new money.

The same amount of money flows into the states. It is just that they have more flexibility on what to do with it. If the secretary of transportation (through the governing bodies) elects not to put the money on maintenance but on something new, the ISTEA legislation would allow him to switch it in those different trenches and then work with the private sector to get the project done. Our road did not have any ISTEA money.

A reasonable question to ask is, when you turn this roadway back to the public, what do you get from the public? The public contribution was to pass legislation to allow the private sector to do this. The Virginia constitution prohibited the state's good faith and credit from being involved in a private arrangement. They entered with us into something called a comprehensive agreement for handling this project. There were no guarantees for anything. But if, for some reason, we would have faltered along the way and could not

have completed the roadway, the public would not have been left with a white elephant. The state had the option to come in and take over.

Virginia did not put in any funding, guarantees, or loans. The right model of this would have had the state make a contribution, but we were facing so many hurdles at the time—breaking paradigms in terms of legislation, moving a very sluggish assembly of politicians from a center in which they had operated for years—it was probably, in defense of Virginia, just too much to ask at the time. The state has since followed through with some super legislation and has been superb to work with. Today, probably, Virginia has the best enabling legislation for public/private ventures in the country. They can now make guarantee-an in kind-type contributions.

Another question for Virginia was how the state ensures that it is not going to take title to a roadway with huge maintenance requirements after our concession period of 40 years? They are protected through this comprehensive agreement. We must maintain and operate this facility at no less than the state standards. So, at a minimum we will be giving them back what they would have had if they had maintained it. And to make sure that happens, they had inspectors out with us during the construction and also during the operation to make certain the standards are met.

In trying to extend the maintenance period from every 7 to every 11 years, we are not deferring required maintenance. To meet the requirement for a roadway of this nature, built to our design, the state expects an overlay to the pavement every seven years. We provided for that. We will have a pavement monitoring system in place during operation to tell us what is going on. We will not overlay unless there is a reason to overlay, so we will be prepared about the sixth year to petition the state and say, ''Based on all of the data we have collected, it does not make sense for us to do this. Don't you agree?''

Regarding the toll rate, there are two relevant government bodies in the state of Virginia, the State Corporation Commission, which regulates rates, and the Commonwealth Transportation Board, which regulates policy. These bodies are the arms for the governor, and they made decisions for us. The Commonwealth Transportation Board decided how the roadway would be managed, designed, and operated, which are policy issues.

Setting the toll rate was a joint decision between the private entity, us, and the State Corporation Commission, and it was negotiated. We had a certain project cost. Obviously the investors, the sponsors, needed an acceptable rate of return because of the front-end risk. A combination of this rate of return, servicing the debt, and operating the road is what set the tolls. We did not break out our funding by task. We had short-term money, which we needed to get the road built, which we have just completed. That amount of funding was provided mostly by a consortium of banks. They have limits, as you know, on the number of years they can loan money. The long-term debt financing was

done by another group of financial institutions, like insurance companies, pension funds, etc.

The initial dollars came from the sponsors. These were the people and the entities who own the toll road. The very first dollars committed to the project are the equity dollars, then the bank dollars, and later the long-term lending dollars. There is an agreed upon cap on the rate of return with the state of Virginia. If the cap is ever reached, the surplus goes into a special account, and we will negotiate about how we deal with that surplus.

In summary, all players, lenders, regulators, owners, contractors, and consultants did a fantastic job on this pioneering effort and should be given proper credit. I was very fortunate to have the opportunity to manage the execution of the project.

Richard Mudge

Apogee Research

We are all in the business of trying to make sense out of words that are so vague they probably have little meaning to most people, the word "infrastructure," for example. Sometimes we think we are going to define it better and call it "public works infrastructure," which probably means very little to most people. Another great word is "privatization," or its refined definition, "public/private partnerships,'' but it is still the same nebulous thing. My current favorite is ''innovative finance" because it makes things sound free. Recently, however, some reality has begun to appear as some actual projects have been created out of innovative financing and privatization—the Dulles Greenway, for example.

To show my bias as an economist, I believe that an understanding of finance begins with economics. Economics should tell us why we care about public works. In very simple terms, infrastructure provides two types of benefits. The first is direct benefits. These are things like travel time savings, clean water, and reduced vehicle operating costs. These are very important because they represent goods or services for which people should be willing to pay. In other words, the financial success of any business, whether public or private, depends on having a potential source of direct revenue attached to it. The second type of benefit is more indirect, to users and non-users alike. These involve market access, productivity, and health and safety benefits. I believe that this second category is an order of magnitude larger than the first.

Apogee Research has just finished a series of studies that started with the Corps of Engineers and passed on to the Federal Highway Administration (FHWA). In this case, since FHWA supported the work, we examined the role of highways in supporting economic growth. Our studies showed that highway investment allows private firms to make more efficient use of their capital, labor, and raw materials. If you translate these efficiency gains into an annual

rate of return, for the last 40 years the nation's investment in highway capital has provided benefits equivalent to a return to private industry of about 25 to 30 percent a year.

The results also showed that the larger the network, the larger the returns. In other words, thinking small is not good for the economy. This finding reminds us why public works are public. The large indirect benefits can be called "public goods," but they are benefits a private firm cannot capture. So when we think about privatizing public works, a key success factor is ensuring that the public sector retains a leading role.

Success in financing projects requires two things: cash, or more correctly, a cash flow, and a financial mechanism. The former can be user fees, dedicated taxes, whatever. In many ways, this is the easier of the two to find. The financial mechanism represents a tool for translating the flow of funds into a real project. Again, I apologize for using examples from transportation, but that happens to be the field I know best.

Within transportation, the key financial mechanism for the last 40 years has been the Highway Trust Fund. The primary financial cash flow for that has been the federal motor fuel tax. The Highway Trust Fund has been very successful. Although it was designed to build the Interstate Highway System, it has also become something on which to hang all the planning and policy work at the national level and, especially, at the state level. It has been a focal point that helps organize planners and engineers. In other words, its success is measured well beyond the financial tool it was designed to be.

The Highway Trust Fund has been broken, however, for at least the last 20 years. In the early 1970s, the Interstate Highway System was basically complete. For the last 20 years, transportation has been searching for an alternative financial mechanism. Three financial options occur to me. The first option is to keep the Highway Trust Fund. It is not necessarily a bad mechanism as long as you put more money into it. The only time that happened on any significant scale was in 1982 when Congress passed a nickel tax increase that went into the Highway Trust Fund. The problem is the lack of motivation. The need to increase funding has been backed up by "needs" studies that show shortfalls in spending of $1 trillion, $2 trillion, $3 trillion, or more. The scale is hard for most people to relate to. Also, it is hard to draw an economic link showing that if we spent all that money, the world would be a better place. Basically, I think this "needs" oriented, more of the same, approach has failed. You can call that strike one.

Another approach is privatization. This is not a new idea. The state of Virginia in the nineteenth century had a policy of matching 50/50 any private firm that wanted to build a railroad, canal, or toll road. The state of Virginia still owns part of the railroad between Richmond and Washington, D.C., because of that.

In the 1980s, President Reagan came in, and there was renewed interest in what the private sector could do, but there were very few successes. Greenway is a success because it is open, but, as General Williams said, it is not something they would do again. State Route 91 is about to open in California in December 1995. This is a high occupancy vehicle lane that will use market-based pricing. They have the authority to change the tolls up to 24 times a day based on the amount of traffic. I cannot imagine it not being a huge success. It was also a painful process and took a long time to implement. There are other examples. In wastewater treatment, there are a growing number of privatized facilities. But overall, there have been many more failures than successes. I would call that strike two.

The third option is to develop a new public financial mechanism. After all, we talk about reinventing government, and there must be new things that can be done. Many of them are already there on paper. The Intermodal Surface Transportation Efficiency Act (ISTEA) was passed in 1991. It contains a lot of imaginative financial tools. Section 1012, my favorite number, offers a tremendous number of good things. For example, it allows public soft loans. You can have short-term interest rates for long-term projects, without being required to pay back until five years after the project is open. This means until a project survives the first set of market risks, the developer can hold off paying the money back. You can restructure the debt over a 30-year period in lots of ways. But four years after ISTEA almost nothing has changed. Since 1991, I can think of maybe three Section 1012 loans that have been completed or are in negotiations, one for a bridge in Laredo, Texas, one for a highway in Texas, and another for a bridge in Florida. There may be others, but there are very few.

Not much imagination has been applied. The Transportation Control Agencies in Southern California managed to sell some $3 billion worth of bonds using an imaginative series of layers of financing, but such imagination is rare. A good question is why more hasn't happened. The simplistic answer is that there are no net new dollars. I find the concept of bribing people to do things that are good for them somewhat odd. There are, however, other reasons these concepts have not taken off. One is that these financial tools are complex and new to the somewhat conservative world of transportation. You are talking about lines of credit, loan guarantees, and soft loans. Also, you are talking to people who manage transportation agencies and have backgrounds either as engineers or planners. You get into fairly esoteric things that begin to sound a little bit like derivatives on top of a world in which they have to relate to the Clean Air Act, metropolitan planning organizations, and other things, and the pace of change is just too much for them to handle. A second reason for slow implementation of these new tools is the need for institutional changes. You cannot just plunk down a brilliant financing idea in the middle of an

organization and treat it in isolation. You have to have a mechanism, which requires institutional change. So I would call that strike three.

It is not that I think the story is over. If you look back at last year's election, two major things happened that influenced transportation finance. First, if anyone ever needed evidence, the election proved the federal government will not be the savior in terms of future financing. Second, it proved there is openness to new ideas, not just at the federal level but at all levels of government.

The most tangible sign of this openness to new ideas in transportation has been what FHWA calls the Test and Evaluation-045 (TE-45) effort. TE-45 is an FHWA program that encourages experiments by relaxing existing federal rules. TE-45 focuses on state financial innovations. This is one of the most brilliant ideas I have heard. There is a provision in federal law that lets the FHWA, on an experimental basis, allow states to propose ideas that may contradict existing regulations. The idea is to develop better reinforcing bars, or better ways of building bridges, and so forth. Jane Garvey, Deputy Administrator for FHWA, and Steve Martin, Director of Innovative Finance for the U.S. Department of Transportation, applied this to finance. They said we will probably approve any financing idea you can come up with, as long as it is not illegal.

In the last year or so they have had more than 70 proposals from about 30 states, involving a whole range of things from cash flow improvements to leveraging to more flexible use of funds. It is an amazing range of ideas. In a sense it provides a test bed for the next ISTEA. Most important, it has stimulated thinking and action at the state level. However, no permanent financial mechanism exists. Ideas are scattered all over the place, and each one is different. Some states have submitted two or three proposals, but there is really no focus.

How can we implement more of these concepts? Is there a way to structure them? I think there are two answers. The first one is very simple, and that is to hire John Platt from the Ohio Department of Transportation. John Platt is my hero. He is in charge of innovative finance in Ohio and is trying to integrate half a dozen different approaches in the Ohio Department of Transportation. The projects involve everything from railroads to highways to intermodal facilities.

What other mechanisms are out there? Well, there are these things called infrastructure banks, which do not quite exist yet. They are the transportation version of revolving loan funds, which have been in existence for some time for wastewater treatment. Unlike wastewater treatment revolving funds, however, which were designed to get the federal government out of the wastewater treatment business, there are really no rules attached to these

infrastructure banks. But there is a focus. How they are used and implemented will depend on the creativity of each state department of transportation.

The recently passed National Highway System Designation Act calls for 10 pilot projects for state infrastructure banks (SIB). Again, no new money has been appropriated, but there is clear recognition in Congress to do something different. The president's 1997 budget proposes $250 million for SIBs. In fact, in some ways this will be the first new idea that has come out of the new Congress relating to transportation. The neat thing about a SIB is that you can hang a lot of things on it. It is not just a way to make a soft loan; it is, in theory, a living financing tool. You can make soft loans to private or public firms, open lines of credit, work in impact fees, provide loan guarantees, or leverage public or private funds.

From the economic and planning perspectives, there are some very nice things to be said about SIBs. First, they allow subsidies. Remember, we are discussing public works that provide public benefits, and subsidies are not necessarily bad. In fact, in many cases, they are required to get projects started. Second, SIBs have a market orientation—something has to be paid back, whether it is a loan or line of credit, or whatever. Projects that benefit from an infrastructure bank must also pass a partial market test, which reduces the likelihood of building unnecessary projects.

Third, and this may be one of the most important thing to be said for SIBs, they encourage planners and decision makers to take a long-term view. One of the nice features of the bond market is you get paid back over 20 or 30 years. If you have a financial mechanism that is going to grow in strength over 20 years, you can focus political and planning power on making sure it works.

Fourth, SIBs are geared to help large projects. One of the biggest problems, in general, in infrastructure funding is that political pressures encourage programs that spread funding across as many jurisdictions as possible. It is awfully easy in most states to get money to resurface highways, for example. But to build something big, you must stop all the other programs in the state for a year, which means, politically, it does not happen.

Finally, SIBs offer a lot of flexibility. You can design them differently for Delaware than for Texas. You can make them suit whatever your local conditions are. Infrastructure banks are also multimodal. There is no requirement that as the money is repaid it must stay focused on a single mode.

I think the wave of the future will be a mix of innovative public and private sector funding. If you look at what states are doing in privatization, they are not following a Greenway model (which has proven painful for both the public and private sector). The states that are active in privatization now—Minnesota, Virginia, Delaware, South Carolina, and so forth—have different models. Minnesota, for example, says they will share risks with the private sector. They are going to kick in $2 million for predevelopment costs to help

the private sector get projects going and $10 million a year to provide subsidies, if needed. The state of Florida is kicking in $70 million a year for the next 20 years for a private high-speed train because they know the project is not going to stand on its own.

Rather than a single national model, I think there will be a family of models, but with differences from state to state. The orientations will be different, but they will probably be flexible enough so they can change over time. In summary, I feel very optimistic about the future for infrastructure finance. I believe it will be better. It will also be different.

Several questions have been raised regarding the long term viability of the Highway Trust Fund for funding state revolving transportation funds as well its possible use in financing other forms of infrastructure.

I happen to believe that the Highway Trust Fund is a mechanism that is past its prime but which, over the years, has become somewhat more flexible. There is some transit money in it now. ISTEA, in particular, opened it up to being used for things that, at one point, were outside its scope. The fund has also been used to help reduce the federal budget deficit, but I think that impact has been exaggerated. There are certain proposals to move trust funds off budget and protect them but I worked at the Congressional Budget Office, and I know we would have figured a way to control an off-budget trust fund.

I think we need a new, more flexible model. When the interstate highway system was being talked about, the original proposal by President Eisenhower was to bond it. A number of people in the Congress, especially Senator Byrd from Virginia, advocated pay-as-you-go. As a result, today we have a mechanism that is a historical anachronism in the sense that it focuses on one system and one type of very conservative financing.

I think we need a set of new models that will be more flexible and, when appropriate, can issue bonds. The true pay-as-you-go concept is over the 20-year or 30-year life of projects. The new models need to be more flexible so that we can consider trade-offs, particularly within transportation, rather than considering highways the only answer.

I think we also need to decide on project-by-project basis what the most appropriate private sector role is. For this, you need a financial mechanism more open to new financial ideas. I do not know what will happen to the Highway Trust Fund. Ten years from now it could be a lot smaller. I think if you ignore political problems, you can make a good case for a publicly oriented infrastructure bank, if you will, that will allow flexibility for all types of infrastructure.

The Highway Trust Fund is politically important, so it will probably stay around. Some of the money that goes to the states from the fund could be used for infrastructure banks. People have talked in the past about turn-backs. The state of Ohio, wants, for example, to intercept part of the motor fuel tax for a multistate compact—something like corporatizing the Highway Trust Fund. I think one of the more interesting things to come from the last federal election is a new Congress with all sorts of new ideas. But they have yet to focus on infrastructure.

One current U.S. trend is for departments of transportation to talk with telecommunication companies because they want to use their rights of way for fiber-optic and other telecommunication systems. Some day you may find departments of transportation owning their own telecommunications systems. Georgia has a huge network for fiber-optics in all of its freeways because they need to get control of traffic for the Olympics. They have the motivation to go ahead and do some of these new things, which, if they had not had one big need, they would not have done for years. The lines between public and private are getting more mixed. If this is happening in the United States, where the model for infrastructure has been 100 percent public for such a long time, it is going to happen abroad as well. This is a somewhat chaotic time. Most of the time it is very exciting.

One dimension that has not been talked about at all is the indirect effects of highway investments, particularly as we push development further and further out to the periphery of metropolitan areas and leave behind impoverished urban cores. The poor in the center of the city, who still have to get to work, are having a hard time finding access to work.

The centers of many of our older urban areas represent a resource that is not being fully utilized. Michael Porter from the Harvard Business School has done some research that says there is significant economic value left behind in our urban cores. How we take advantage of that is another question. The state of Delaware is trying to implement some public/private legislation in a very different way. They are preparing to take bids from private firms to invest in transit or some urban-oriented intermodal facility as one possible option. That will require some subsidies, but the state department of transportation will also provide financial incentives for the private sector to put ideas and money in places we normally pass by. Most public/private projects around the country have been bridges or big toll roads because those are likely winners. There may be a different model out there that would help indirectly get at the issue you are talking about.

Looking at other infrastructure in this country, public surveys rarely find a negative reaction to water supplies being privately owned, per se. There is, however, often a negative reaction to having to pay for something the public used to think was free. That is the real problem to overcome. It is also clearly

the trend in this country and around the world that more and more projects will fully depend on user fees, whether a project is sponsored by a private firm or public agency. In certain parts of the country, Orange County, California, perhaps, being private may actually help.

A broader change is that public infrastructure, in general, whether publicly or privately owned, will be operated more like a business. Private ownership is not necessarily a big negative. Paying for a toll road you did not have before is probably a bigger issue than whether it is privately or publicly owned. The privatization model going forward will look a lot like a public agency that acts like a business.

Ann L. Sowder

Government Finance Group, Inc.

I have been asked to reflect on the investment community perspective on infrastructure finance. First I want to give you a flavor of who comprises the investment community. Then I will move into a general discussion of new approaches to financing infrastructure in the United States. Not all of these approaches are new in the sense that they have been used for the first time in the last few years, but they are still new in many instances because they are not widespread. I will touch on some of the same examples the previous speaker mentioned, but I will put them in a different framework for us to consider.

Finally, I want to elaborate a little further on start-up toll roads in the United States. We have had several recent examples of large financing for these projects, a noteworthy development in terms of what is getting done in infrastructure finance, and they involve the investment community very intimately.

My first topic is who comprises the investment community. You have, on the one hand, debt investors. You heard General Williams mention the tiering of financing that underlies the Greenway project. He mentioned in that case short-term investors—bank financing—for construction and long-term lenders as part of their financing consortium. In the United States, in municipal finance, construction financing and long-term financing typically come as part of the same bond deal, and that is a distinction that is important to understand relative to the Greenway project. To some extent, I am going to use the Greenway project to draw some contrasts because it is so unusual. It is very different from most infrastructure projects in the United States that use public and private investment funds. Keep in mind that the Greenway project used taxable rate financing and that most public infrastructure financing in the United States uses tax exempt financing, which involves a whole different set of rules and players.

Debt investors receive a fixed return that is generally defined in terms of the timing of when they receive that return and fixed in terms of the rate of return. Among the debt side players, we have institutional investors. For the tax-exempt market, we are talking primarily about mutual funds. There are also individual retail investors, although most of the investment by retail investors these days is through the intermediary of mutual funds.

I would include on the debt side of financing rating agencies, which serve as proxies for investors and play a very important screening role in looking at projects. Rating agencies assign designations that rank the credit worthiness of various projects. To have access to mutual fund financing and access to retail investors for selling tax exempt bonds, the normal way to go is for a project to receive a rating. The rating must be above a certain threshold, which in the terminology used is "investment grade." That designation includes the AAA, AA, A, and BBB and Baa categories. These projects are the cream of the crop, although projects do get done that are not investment grade. But bigger projects, the ones we have seen lately that are attracting a lot of attention, have succeeded because they were designated investment grade. Rating agencies and how they look at projects are the first indicators of concerns that very much reflect what actual end investors are looking for.

We also have equity investors in projects, although in the kinds of projects that I am going to describe, equity investment is a bit of a misnomer or is not a major source of funding. Defining the difference between debt investment and equity investment can get a little fuzzy in the sense that highly subordinated debt lenders often, effectively, venture capitalist investors. That is the same sort of phenomenon we see in the corporate market where subordinate debt is really more akin to equity investment than to debt financing.

In the case of the Dulles Greenway, reference was made to equity investors. Another distinguishing factor of the Greenway project, which works against being replicated in great numbers, is that a lot of the willingness to contribute high-risk equity financing came from the expectation of related return on real estate owned by some of the parties in the immediate area. So, this was equity investment that is not typically what you think of as equity investment. It is not "stocks" in the normal sense of the word.

Another quasi-equity investment involvement that we see in financed infrastructure projects is contingent commitments, money put at risk (i.e., guaranteeing a commitment) from construction consortiums. This is a very important quasi-equity form of investment. It is especially important in the early stages of a project for getting the project to the point where you can attract publicly sold debt. Some of the projects I will refer to later had definite layers of construction-consortium committed capital, which were at the bottom of the totem pole of getting repaid but were absolutely critical to the success of those projects.

With debt financing, you have debt investors, equity investors, and intermediaries between the sources of capital and the projects that need the capital, who are also considered part of the investment community. Investment bankers and financial advisors, such as my company, are intermediaries. We bring together projects and investors and work to structure financing so that the flow of capital from investors to projects takes place. The most important distinction between the investment banking community and financial advisory firms like mine is that investment banking firms are involved in actually underwriting, putting capital at risk, in order to sell the securities that make up the financing. Companies like the one I work for are not involved in the selling process of debt. We only advise on the planning and packaging of financing.

That gives you an overview of who is included in the investment community because financing in the United States is primarily driven by cash flow and is not asset based. For the most part, the financing of infrastructure projects revolves around different types and different layers of debt financing, basically with fixed rates of return and a defined schedule by which the money is to be repaid.

I want to reflect on how the investment community has been involved in infrastructure finance and the criteria they use in deciding which of the newer types of projects merit investment. Let me turn to some of the new approaches to financing infrastructure in the United States. There are two objectives underlying many of the approaches that are being used more frequently these days. The two objectives are, first, to use existing funds more effectively and, second, to attract new money, new investment funds for infrastructure. I want to review several of these techniques and categorize them along these lines. Essentially, are they taking existing money and trying to use it more effectively, or are they trying to get new money into the system?

One option related to more efficient use of public funds is using loans rather than grants. The Environmental Protection Agency (EPA) state revolving fund program that was instituted in the mid-1980s is probably the prime example in the infrastructure finance area. This program represented a watershed change in the financing of wastewater facilities in the United States. It basically took a grant program and replaced it with a loan program. Injecting the financial discipline of repaying loans into the process has, based upon various studies and critiques of the program, been positive.

One problem that remains is that under the old EPA program some communities could barely afford to come up with matching funds. If they could not afford the match before, they are certainly not in a position to repay loans now, and they are, in some cases, effectively left out of using loans as a financing option. But for most projects and communities, the loan program works because there is already a revenue stream in place, that is, water and

sewer utility charges. Because there is a user fee that people are used to paying, it naturally feeds into using a loan mechanism.

Using loans rather than grants has introduced into the funding process recycling of capital, which that ''stretches'' money and uses it more effectively. Some of the state revolving loan programs have used debt to further increase the amount of money they have been able to lend out via the loan process. In general, various studies have found that the leveraging ratio is in the neighborhood of three to one, meaning agencies have been able to borrow funds roughly equal to three times the initial seed money (the equity contribution from the federal government). This is probably the prime example of using federal capitalization funds to replace grant programs and using a limited amount of money in a more effective way.

The infrastructure bank concept is very much under discussion presently. If it does not get through as part of the National Highway System Designation Act of 1995, you can expect that it will be back in the discussions of the reauthorization of ISTEA. The idea of making loans rather than grants for transportation financing is partly based on the experience of the EPA wastewater program. There is a real opportunity to do better when applying this concept to transportation. It will require a new way of thinking about highway projects because with most highway projects, as opposed to wastewater treatment projects, you do not have an existing ready-to-tap user fee revenue stream with which to repay loans. So, the concept will be harder to apply in the transportation area, but it promises more effective use of money in the federal trust fund which, for the most part, now goes out in the form of grants.

Another mechanism of using existing funds more effectively, stretching them, if you will, is federal lines of credit. However, this financing mechanism is available only in special cases at this time. Two large toll road financings in California had access to lines of credit from the federal government. Both the Foothill Eastern Toll Road Project and the San Joaquin Hills Project were done through transportation corridor agencies in Orange County. Each project has the ability to draw up to $120 million from the federal government to offset operating costs, shortfalls, or construction cost overruns and deficiencies. These lines of credit are available—in the case of the San Joaquin project—for five years after completion of construction and—in the case of Foothill Eastern—for 10 years after construction. The debt financing for these two projects did not rely, in terms of total repayment, on the lines of credit, but they were tangible evidence of federal support for these two very large, precedent-setting projects.

One rationale for having an infrastructure bank is the possibility of setting up the banks for transportation on a state or regional level using federal monies channeled through the states from the federal trust fund. Using those banks to provide lines of credit is one option.

Similar ideas for using state monies to enhance project financing can be found in a number of states, including Maryland and California, which already have state laws and mechanisms in place whereby localities have access to lower cost financing by diverting formula-distributed amounts from state transportation trust funds to pay debt service on bonds issued to finance local projects. This is an interesting parallel that has implications for transportation infrastructure banks, if they are set up, because it provides a ready stream of repayment money for projects and allows you to leverage. Several states are doing it, including Virginia, and I think more states will turn to it. It is a financing, or credit-enhancing, mechanism that is used widely for schools, for example. The opportunities for transportation are just now really being explored.

Moving from ways to use existing money more effectively to ways to raise new money, increased application of user fees is clearly the name of the game. Tolls, special assessments, and proffers are the primary ways this has been done in projects to date.

User fees in the transportation area do not necessarily mean only tolls on highways. One of the very interesting projects that John Platt from the Ohio Department of Transportation has put in place is an intermodal facility for transferring containerized cargo from trains to trucks and vice versa. A fee will be charged for use of the crane that transfers containerized cargo. This is, in effect, a toll on a different kind of activity. Mr. Platt is one of the most unconstrained in his thinking about how to find revenue streams. His philosophy is, basically, if there is a benefit, there may be a way you can charge for it. Then you can use that revenue stream to do a lot of different things. In this case, the up front financing for the crane, which is going to be at the heart of this intermodal facility, is coming by way of a loan from the state and will be, ultimately, funded in large part by federal funds. The loan will be repaid from user fees, the lift fee charged as part of this project.

With regard to start up toll road facilities, I will just make a few comments about special assessments and proffers. It is important to understand that, generally, special assessments as they are used and applied around the country are a recurring type of revenue stream that allow you to bond against the payments, which occur over time. Proffers, by contrast, are one-time, up front payments made at the time an occupancy permit or construction permit is given. Generally speaking, proffers can not be bonded against. They generally figure in as up front contributions to a project but do not figure into bond issues.

A second kind of effort to attract new investment funds into infrastructure investment is partnering. We have heard various references in the preceding discussions to public/private partnerships. We are also seeing a lot of public/public partnerships.

Public/private partnerships are really a mechanism for structuring transactions, which in and of itself is not going to attract private investment funds to a project. In order for private capital to be generated by a public/private partnership, you have to have a way for the private party to earn a rate of return. For the most part, that means having some sort of user fee. In the transportation context, that has generally meant a toll.

There is a lot of activity in this area. Private parties, such as construction consortiums, are interested in pursuing the right kind of projects and investing their own money up front in the planning. Once these projects get to a certain point, investors show increasing interest in and acceptance of investing in the debt sold to finance these projects. Some projects are public/public. In an increasing number of states, the toll authority is working with the state departments of transportation on projects with a degree of cooperation that has not been seen in the past. I think that departments of transportation working more closely with toll authorities is a trend we are going to see more of in the future.

In the last few years, more than $3.5 billion of investment capital has been contributed to four start up toll road projects alone: the two California projects I mentioned earlier, the Dulles Greenway, and the E-470 project in suburban Denver. E-470 is a loop road that goes almost all the way around the Denver area and will also serve the new Denver airport.

These projects have been accepted by the investment community and have received a tremendous amount of investment capital because of several characteristics they have in common. First and foremost has been a degree of public support. The commitment of local governments and state governments behind these projects and viewing them as alternative ways of providing transportation infrastructure not in competition with the state government, has been key to investor acceptance. A second element that has affected positive reaction from the investment communities relates to the nature of the projects. The two California projects relieved existing congestion, as distinct from the Dulles Greenway or even E-470, which were built more to spur and accommodate future growth. In general, investor reception has been stronger and more positive towards projects to relieve congestion because the users are already there. Other projects may get done, but at higher interest rates. They are harder to do.

Some other factors have increased investor acceptance. Construction guarantees have been critical to getting over the hurdle of the initial uncertainties of a project. Up front investment by construction consortiums with considerable financial wherewithal themselves has been key to investor acceptance. Also, computer modeling has advanced the science of making traffic and revenue forecasts, a critical area of expertise. But some of the projects financed with large deals have also greatly benefited from having small

segments of the system already open, especially if projections were reasonably accurate for those segments. A lot of people will be watching projects like the Dulles Greenway to see how close the actual numbers come to projections. The success of many follow-on projects may be affected by how well the forecasters have done on the projects that have been financed to date. Finally, investors have reached a comfort level with increasing debt service schedules on these projects and using substantial reserves as part of the financing. That is a real watershed change, but it is a tangible indication of investor belief in these projects and the purposes they serve.

Taken all together, we see a lot of interest in financing infrastructure projects. If the projects that have been financed in the last few years turn out to be even reasonably successful, many more projects will be coming behind them. Investors and rating agencies have broadened their way of thinking about these projects, and there are new ways of getting things done. We think there will be more to come.

Participant: Do you know to what extent the landowners who participated in the Greenway project subjected their land to debt to generate money to buy the equity shares of the road? I question exactly whether it was a transportation project or a land development project. I was just wondering how much the two were interrelated.

Ms. Sowder: General Williams would be better able to give you some specifics on that. I do not know how the equity investors in that deal financed their contributions. I know some were personally very wealthy. Whether the others effectively took out loans on their property to help front that money, how that was secondarily financed, I am sorry I do not know.

I think your premise is right, though, that the deal was very real estate development driven. That deal would not have happened had there not been significant contributions of at-risk capital by those landowners. The tier of debt that goes ahead of that equity investment is from traditional lenders, insurance companies and pension funds. They got a very good rate of return on their investment.

The attempt to refinance that package prior to the opening of the road did not go through. I am not privy to all of the reasons, but I have to think that part of the reaction of the financial institutions was that they wanted to see actual use of the road before they agreed to take out some of the equity effectively and replace it with more debt financing.

Certainly Greenway has been a success story to this point in terms of the construction story, but the jury is still out on that road. It will be very interesting to watch. I get nervous about it, because I am fearful that so many other projects in the future may be adversely affected if Greenway does not play out well. I do not think that is necessarily a linkage because the Greenway project was so different.

Participant: A related question for Ms. Sowder. Early on, as U.S. companies tried to become involved in international private/public partnerships, many of the negotiations foundered on the concept of profit and compensation for risk. Have we seen the same thing here as these kinds of projects have been negotiated in the United States?

Ms. Sowder: That has not been the stumbling block. Fundamentally, the stumbling block for a lot of the public/private projects has been getting public support for the projects. We can look at the experience of five projects in California that are collectively referred to as the AB680 projects, which is a reference to Assembly Bill 680. The bill gave CalTrans, the state department of transportation in California, the ability to enter into franchise agreements that underlie several innovative projects that began five or six years ago or more. The bill allowed for negotiated rates of return on those projects.

Those projects are more like the projects that have followed, and they are fundamentally different from the Greenway project in this respect. Greenway fits a model that is typically referred to as "build, operate, transfer." General Williams talked about how the state gets the project back at the end of the 40-year franchise. The California roads were done in a mode that is typically referred to as "build, transfer, operate."

The private franchisee constructs the project, and then ownership of the project is turned over to the state. The state can enter into a lease agreement with the developer for operation of the project over a specified term, and the franchisee operator receives a negotiated rate of return. The operator has the flexibility to charge tolls. If they charge tolls that result in a rate of return in excess of the negotiated rate of return, the money has to be used either to retire debt or be given back to CalTrans. That is the approach California used.

Washington state, which embarked upon a very high-profile public/private process over a year ago, also started with the idea of negotiating rates of return. Virginia, which has just begun a new public/private project solicitation process, has set up the process so they can negotiate the rate of return on a project-by-project basis. Virginia is using a very different approach the second time than was used with Greenway, which had to go through the State Corporation Commission. That was basically a utility model of regulation.

The jury is still out on public acceptance of a given rate of return being earned on these projects. I have heard comments regarding the State Route 91 Project in Southern California, which involves charging tolls for using a high-occupancy vehicle lane in the middle of the Riverside Freeway, that this project might be too successful and earn too much for private sector investors, possibly hurting public acceptance of similar projects in the future. So we really have not gotten to the point yet where we have seen actual operations of some of these big, high-profile projects. That will be an interesting one to watch.

In Washington state, as I said, the problem affecting many projects is building public support for them. These projects have not gone forward far enough to test the rate-of-return aspect of the negotiation. They ran into a lot of public acceptance problems because of public resistance to tolls. Almost all of the projects there relied in some way on tolls.

From what I understand, there was also some resistance that arose from the fact that when you were dealing with private parties on these proposals there was, and I think rightfully so, attention paid to the confidentiality of information and proposals. The public, however, felt shut out of the review process. I think for the most part that is an unfair criticism, but often perception is reality. A lot of the public resistance has been more directed towards the idea of charging tolls and how projects are selected. There will be more projects to come, so we will have more examples to look at in the future. But only a few projects so far have gotten far enough along to get public reaction to negotiations on the rate of return. For the most part, these have been between state departments of transportation, local sponsors, and private consortiums.

Participant: One concern I have, maybe an issue that relates to similar public/private partnerships, is that politicians tend to make decisions on a short-term basis. Landowners are looking at the long-term benefits. I am thinking of the case of a regional airport or tollways running to a certain location. If private interests or long-term profits could influence the location of an infrastructure facility or a tollway or whatever, that would not necessarily be in the public's best interest on a long-term basis. But it might influence politicians on a short-term basis to accomplish something.

Ms. Sowder: Certainly that tension is there. I will fall back on some of the lessons learned from the experience with the two recent California toll roads. These projects were so big that even though the state had originally identified them, there was no prospect of funding them for many years to come. In California, the legal mechanism is joint action agencies. So a consortium of Orange County and cities in that area decided to pursue the project themselves.

Both projects were so expensive that they could not be built without a lot of help from the state. I do not mean just financial help. We talked about the federal line of credit, which is an indication of federal support for these kinds of projects. They were very big and originated out of state-identified plans that were not really susceptible to being driven by developers, albeit the Irvine Company in Orange County was very involved. They had a significant real estate interest and stood to benefit from spin-off development from both roads. Certainly their political persuasion should not be underestimated. These are examples where the local jurisdictions decided that they were going to step up to bat and make these projects happen because they did not see the money coming from the state.

On a smaller scale, there have been projects that, in retrospect, everyone agrees were too heavily influenced by particular developers. The history of special district financing is littered with situations where inappropriate projects were built—situations of excessive or inappropriate borrowing, of districts where the board was composed of appointees so the relative distribution of voting power was divided up by land ownership and a single developer could basically drive the decision to issue debt, of debt issuance running absolutely amok, far beyond the capacity of what the area could support.

There are also many examples of private development interests using the process to get debt issued that, sometimes, could not be repaid because development slowed down. The celebrated abuses of this process have resulted in reforms in many of the states that first used these financing mechanisms. Other states, particularly when they have looked at special district financing, have learned from these successes and failures. Now there is a body of experience that can help state and local governments set up a process—a lot has to do with governance issues as well as debt capacity—to make appropriate use of the user-pay mechanism without totally skewing priorities for projects.

Dr. McDowell: Let me give you another example. I was out in Las Vegas, which of course is a unique city. I did not realize until I got there that it has a population of one million people. In the next 7 to 10 years, they are looking at another million on top of that, which probably makes them the fastest growing place in the country. You know the place is dominated by one industry. It also has a lot of people out there in business who like to make decisions one day and act on them the next.

Well, they have a substantial transportation problem, a lot of it in the casino corridor. The federal transportation planning requirements say that when you have a problem like that you have to do a major investment study. It lays out the whole multiyear process. They are about a year into it, and it is going to take two more years. The city has started solving this transportation

problem, and they have invited casino owners to be a part of the process along with others from the community. The casino owners sit there and nod their heads, but they do not give input.

One of the owners already has built a one-mile monorail to connect two of his casinos. Another casino owner decided he wanted a direct connection to the airport, so he was going to build it. What stopped him was not government but the other casino owners who decided this owner would have an unfair advantage. In the remaining two years of the planning process, government does not know what to do because the planners are afraid the transportation system will be built before it is planned. The bottom line is that the required public process is too slow to respond to this dynamic situation.

The only thing they have made any headway on is trying to convince casino owners that they should look not just at the casino attendees, the resort people who are being attracted, but also at their employees' needs. That idea has begun to sink in a little bit, but aside from that, casino owners are really pretty much on their own track.

Mr. Tischler: Maryland has been working for several years on a major investment study for the multi-million-dollar U.S. 301 corridor project. They requested consultants on a volunteer basis to review their projections because obviously land use projections drive the planning assumptions. We found that they had forecast the District of Columbia to expand by, I believe it was 188,000 jobs between 1990 and the year 2015. In fact, so far during the 1990s, the District has lost jobs. However, regardless of the actual numbers—perhaps the District will add 50,000 jobs—the point is population projections developed by the Metropolitan Planning Organizations, i.e., the Washington Council of Governments, must be used for project planning. Those of you who have worked on population forecasts know how political that process is.

My point is that millions of dollars are spent on these major investment studies which require several years to complete, and in the case of the 301 corridor, result in transportation alternatives based on an unrealistic set of employment projections. This generates a planning scenario of light rail linked to Metro by express buses using dedicated lanes when, in reality, the situation will be far different. So now these people have been in the process for two years, and maybe they have to go back to the drawing board. It is very frustrating for both the citizens who are participating in this project and the private sector.

Paul S. Tischler

Tischler and Associates

I want to talk about three areas: finance and accounting, planning, and revenue.

In the area of finance and accounting there are some realities, some of which may be obvious but are worth noting. In many jurisdictions, the infrastructure replacement costs are significantly greater than the need for new infrastructure. Increasingly in a community that is growing, the emphasis is on new because the community is already getting behind.

The second point about finance and accounting is that infrastructure costs are usually only about 10 to 20 percent of a jurisdiction's budget. In fact, the associated operating costs are usually more significant than capital costs. Our firm has been involved in several cases where the jurisdiction decided to postpone opening a new facility that was almost finished in order to avoid paying operating costs. For example, although the cost of building a fire station and providing the apparatus can be significant, the annual operating costs of full-time firefighters dwarf the annual capital costs. It is always interesting when I go to local communities that the discussion of retrofitting a facility or adding a modular addition takes up more time in public hearings than the operating expenses, fringe benefits, and other things that really eat up budgets.

The last point about finance and accounting is that it is surprising, when you think about it, that most jurisdictions do not have a depreciation account. Most private sector enterprises have a depreciation account for capital assets. That is, as a facility ages, the company sets aside money for replacement. In the public sector, water and sewer utilities routinely budget for replacement. Unfortunately, except for utilities, most jurisdictions do not maintain depreciation accounts. No money is set aside, and most older communities, consequently, are facing a "time bomb" when it comes to rehabilitating or replacing existing capital facilities. That means a community

meeting capital facility needs arising from demands from growth, and there are very few of those, is not addressing at all the needs for the remaining useful life of existing infrastructure. The cities are the worst examples of that.

Two exceptions are cities we worked with that did establish capital facility replacement funds—Plymouth, Minnesota, and Germantown, Tennessee. Both jurisdictions had common characteristics of progressive leadership and citizens interested in their physical future. But they are almost unique among cities. In growing jurisdictions, operating costs must also be evaluated. In older communities, funding the replacement of existing facilities must be addressed.

In the area of planning, most jurisdictions are operating under such severe fiscal constraints now that they are just concerned about meeting the current operating needs of their jurisdiction, not about aggressive long-term capital improvement program (CIP) budgets.

The availability of basic infrastructure, such as water, sewers, and roads, opens up areas to new development. On the other hand, new development in an area generates the need for more capital facilities and equipment, such as schools, parks, libraries, police cars, and fire and rescue equipment. Unfortunately, when projected revenues are not sufficient to meet expenditures, the CIP suffers. Invariably, if a jurisdiction needs to save money, it may freeze vacancies but will not lay off staff. Instead, the six-year CIP will be postponed, again. This results in continuing backlogs for needed infrastructure.

Postponing capital facilities is likely to decrease the level of service, a key problem of infrastructure. For example, many communities have adopted comprehensive land-use plans. However, providing needed roads recommended in the plan can not keep pace with growth. The result is a deterioration in the level of service for existing and new residents.

In addition to the decrease in the existing level of service, there is another phenomenon. This is the level of "service creep." Service creep has generated greater (little understood) impacts on communities than the effects of new growth. For example, statistical studies show that there are more cars per capita, more trips per car, and more vehicle miles driven per car than there were five years ago. As a result, the same population generates an increased demand for roads to maintain the same level of service.

Another example is schools in Baltimore County, Maryland. We were hired by the chamber of commerce in Baltimore County to find out how Baltimore County schools got in the position they were in and what to do about it. Schools and transportation are the two major local infrastructure issues, and schools are more influential in land-use decisions and movement, etc., than transportation. Home builders did not want to be shut down and were being threatened with a moratorium on schools.

What created this conflict was postponing necessary construction and service creep. Beginning in the 1980s, Baltimore County did not want to raise taxes or expand schools. Ten to fifteen years later the number of students in the school district was the same, but the requirement for classrooms had almost doubled. The reason was the increased level of service—fewer children per classroom, required special education and other programs, and electives local residents wanted to implement in the school system. The impact is not only on the size of classrooms, but also on operating expenses, additional teachers, etc.

The solution was to reduce the level of service. They could not afford the level of service because they did not have the debt capacity to build that many schools and they did not want to raise taxes. We said they had to increase the number of pupils in the class because otherwise the situation was hopeless. When this hit the front page of the Baltimore Sun, the Parent Teacher Association president was quoted as saying, ''They were not asked to look at level of service. That is crazy.'' The next year they, in fact, had to reduce the level of service by adding two pupils to each class. Relatively few residents understand this phenomenon. They assume the shortage of infrastructure is due to new growth and not to increasing demands for service by existing residents.

That is an example of how levels of service change, which, to me, is the major reason jurisdictions cannot afford to operate and meet the challenges of growth. A sidebar of that example is the development community in Baltimore County, who said, they were willing to pay their fair share, willing to pay impact fees. That is the first example I know of where a development group proposed paying impact fees so they could build.

Another planning issue is that infrastructure can significantly influence new development patterns. That point is obvious. But the fourth point under planning issues is very important. Infrastructure costs generally increase as density decreases, what I call "cost of sprawl." The tendency of infrastructure costs to increase as density decreases is only part of the financial picture. This gets us into revenue issues, an entry into the next topic and the third area I want to talk about.

To find out the impact of infrastructure on a community, you have to do a fiscal analysis, which can be defined as cash flow to the public sector. To analyze cash flow, you look at all the revenues, all the operating expenses, and the capital costs. Very few jurisdictions are doing this kind of fiscal impact evaluation.

Howard County, Maryland, is an example of the cost of sprawl concept. In the state of Maryland, income tax reverts to the county government, there are transfer taxes, and there are substantial property taxes. Those three components are critical revenue ingredients in Howard County. Because of this structure, revenues accruing from higher valued housing with higher incomes more than offset the infrastructure costs of low-density development. From a

fiscal perspective, low-density development makes more sense than high-density development even though the infrastructure costs are greater. Any of you dealing with local communities should be aware of this "opposite" result, which is not evident from just looking at infrastructure.

The methodology for a fiscal impact analysis should be a case study-marginal cost approach, versus a per capita average cost approach. The per capita average cost approach to a fire department budget, for example, would divide the budget by population to arrive at a per capita cost. This per capita cost would be the same regardless of the spatial distribution or timing of new developments. In contrast, a case study-marginal cost approach would consider the fire department's response time to serve a new development. It would also consider whether existing fire stations could serve the new development or whether a new fire station should be built. An example is the addition of 1,000 homes in somewhat of an in-fill situation, versus 1,000 homes in a leap-frog situation. The former would probably generate no additional costs in constant dollars. The latter would probably necessitate a new fire station, apparatus, and annual staffing costs.

In many jurisdictions, the costs of new capital facilities and other services are greater than projected revenues from new development. One reason for this is a decrease in state and federal funding at the same time that both voluntary or required mandates have been imposed raising the required level of service. Because elected officials are reluctant to raise property taxes, new funding approaches are needed. By conducting a fiscal impact analysis, a jurisdiction can focus on how development and the provision of infrastructure and related operating costs will affect the need for additional revenues.

Little Rock, Arkansas, is an example of what is happening throughout the country. Little Rock, unfortunately, is a case of both cost of sprawl and level of service creep. Little Rock annexed and doubled in size in the 1980s. In older areas of the city, the infrastructure is deteriorating because money was not being put into the older community. People in the older areas felt they were being neglected and that new growth was sapping the resources of the city. On the other hand, developers felt they were paying their way with revenues generated from new growth. We looked at the fiscal impact of development. Every community is unique, but in the case of Little Rock we found that new development did in fact pay for itself. The major reasons this was true were the market value of new housing, the relatively low level of service, and the fact that the developers had to build capital facilities.

Then we looked at why the infrastructure quality of life was deteriorating in older parts of the city. We looked at the cost of disinvestment in older parts of the city, as far as I know the first time this has been studied. The cost of disinvestment is a very important issue that large cities need to address more than they do. Older portions of the city were losing residents. People

wanted to move out of the city or into larger housing. They did not have any more debt in their houses. The housing values were not very high (it is a low-cost city). They basically were giving their houses away.

The costs of disinvestment to the city are loss of revenue, loss in assessed value, which translates directly to property taxes; and an increase in costs. The city incurs direct costs for community-oriented police, housing inspectors, street lighting, animal control, arson investigation, judicial activities, and demolition of housing units. The city loses revenues as units are demolished and existing units decrease in value.

The point is that the cost of disinvestment far surpasses the net revenues from new development. Does that mean you should stop new development? No, because people will go elsewhere, across the city lines. By the way, the city of Little Rock is attracting 80 percent of the employment base in the whole metropolitan area, and you still see these results. So the city is now engaged in revitalizing the downtown and older neighborhoods. We provided them with examples of successful redevelopment from other cities throughout the country.

Even Boise, Idaho, a city that is growing, has fiscal problems. We just looked at development scenarios in Boise. I suspect most people would think of Boise as a healthy city. In all of the growth alternatives, we showed that new growth generated a need for $4 million to $5 million a year extra out of other city revenues. Boise cannot even afford to meet capital improvement replacement programs. So even a city like Boise, which does not have many of the urban problems you find in the eastern half of the country, has fiscal problems.

I believe that there are solutions to local financing, and they are quite simple. The mechanisms are there to increase sales taxes, gasoline taxes, and income taxes. I am talking about a quarter or half of one percent. The base is so large that those dollars coming back to the community can be substantial. Unfortunately, most states do not want to authorize localities to even put tax increases on the ballot.

There are various possible approaches to either accommodating or curbing the need for infrastructure. Some of these are revenue mechanisms. These could include:

• special or assessment districts

• private financing

• impact fees

• developer contributions/agreements

• revenue bonds

• real estate taxes

• real estate transfer taxes

Other, nonrevenue approaches could curb or monitor the need for new infrastructure. These include adequate public facilities ordinances and transfer of development rights ordinances that make it possible to reassign development intensities from low density areas to areas where growth is desired.

Transfer of development rights provide some flexibility on certain things. I talked with previous speaker Ms. Sowder about "takings," or legislative actions that are confiscatory. Taking issues are a concern now in Congress. The issues around compensation for property owners for regulatory actions will put a damper on planning department efforts to become or remain aggressive. But there is no corresponding discussion about what is given. If you have to pay somebody the value of the land you are taking, then what about infrastructure improvements on behalf of landowners? They are being given something. Well, it might make sense to talk about that half of the equation, too, and trace a transfer of development rights.

Impact fees raise several issues that are symptomatic of what is happening today. First, there is the intergenerational equity issue. We paid or our parents paid for infrastructure for us, but we are no longer willing to pay for infrastructure for our children, or at least not the full bill. This is a dramatic change. I think it is due largely to not understanding the level of service creep.

In some communities developers have been told, "You want to fight us in the state legislature to implement impact fees? That is all right. We are going to implement an adequate public facilities ordinance, which means unless we have capacity for new development, we are not going to allow it to be authorized." There have been several states where that threat has been made, and they have allowed the new revenue exaction of impact fees.

By the way, the National Association of Homebuilders has not come out against impact fees. The reason is that responsible builders realize that—because of cutbacks in federal and state funds and the timidity of local officials about raising taxes—there have to be other revenue sources. Impact fees require a rigorous process on the part of jurisdictions to come up with a justifiable fee structure. Developers have a certain amount of time to pay and develop, and they know the money is going to be spent for new development.

An example of a special agreement, like a special assessment district, is Douglas County, Colorado, just south of Denver, which had school impact fees. The case was thrown out of court, but developers "volunteered" to pay impact fees, even though they did not have to because they were worried they might not otherwise get approval from the local jurisdiction.

In conclusion, I think there is a lack of education of the public about what has happened in providing services. People do not understand the cost to a police department of having officers handle child abuse cases, for example. It is the same with education. One child more or one less per class has a ripple

effect on the level of service and on infrastructure costs. By fully understanding the capital costs, operating expenses, and revenue sources available to a jurisdiction, a community can better understand how it can meet the demands of new growth and maintain the level of service to current residents. By going through this process, the community will also be "educated" on the need to budget for replacing existing infrastructure.

Until people are better educated, there will continue to be a ripple effect of a lack of confidence in government. Until the basic lack of confidence in government is overcome, there is going to be great reluctance to allow more revenues to jurisdictions to pay for their needs. If localities do not have the revenue mechanisms they need to solve these problems, we will fall further behind in providing necessary infrastructure, which will ultimately lead to decreases in the levels of service.

George Bugliarello is chancellor of Polytechnic University, chairman of the Board on Infrastructure and the Constructed Environment of the National Research Council and a member of the National Academy of Engineering. He has chaired the Board on Science and Technology for International Development of the National Academy of Sciences, the Advisory Committee for Science and Engineering Education of the National Science Foundation, and has consulted on numerous international assignments. Dr. Bugliarello chairs the Metrotech Corporation, established by Polytechnic University to create Metrotech (a university-industry park in New York City). He holds a doctor of science degree in engineering from Massachusetts Institute of Technology and has been awarded several honorary degrees.

Timothy J. Brennan is a professor of policy sciences and economics at the University of Maryland Baltimore County Campus and senior fellow at Resources for the Future in Washington, D.C. His research has been focused on regulatory economics, antitrust, and numerous information issues, including regulating broadcasting, the First Amendment, and copyright. In addition, he has published papers on the ethics and philosophy of economics. His articles have appeared in journals specializing in economics, philosophy, communications, and law. Among his current research topics are regulatory "takings," structure of the telecommunications market, deregulating electricity, privacy, measuring environmental damage, and the role of moral rights in making public policy. Dr. Brennan has a Ph.D. in economics and a M.A. in mathematics from the University of Wisconsin.

Natalie R. Cohen is president of New York-based National Municipal Research and publisher of Fiscal Stress Monitor, a monthly publication that analyzes regional and local trends affecting the fiscal condition of state and local governments. The publication was launched in the fall of 1994 and

includes a subscriber base of rating agencies, bond insurers, commercial banks, broker/dealers, money managers, academics, government officials and the press. Ms. Cohen's more than 15 years of experience in the municipal industry includes rating credits at Moody's Investors Service in the Public Finance Department and supervising the planning of New York City's $8 billion education budget at the New York City Office of Management and Budget. She is a member of the National Federation of Municipal Analysts, the Municipal Analysts Guild of New York, and the Municipal Forum and has been a member of the Public Securities Association Credit Research Committee. Ms. Cohen has a B.A. degree from Hampshire College in Massachusetts and an M.P.A degree from the Robert F. Wagner School of Public Service at New York University.

Nancy Connery is a private consultant, author, and lecturer on public investment, management, and infrastructure issues and a member of the Board on Infrastructure and the Constructed Environment of the National Research Council. She is the former executive director of the National Council on Public Works Improvement and serves as advisory editor and contributor to The Public's Capital, an infrastructure newsletter published jointly by Harvard University and the University of Colorado, Denver. Ms. Connery has received the Silver Hard Hat Award from the Construction Writers' Association, Distinguished Service Award from American Public Works Association, and the Rebuilding America Award from CIT Group/Equipment Finance. She received a masters degree of public administration, as a Lucius Littauer Fellow from the John F. Kennedy School of Government, Harvard University, and a bachelor of arts cum laude in political science from Pacific Lutheran University.

Carol Everett is the director of special programs for the American Public Works Association (APWA). She is responsible for managing and developing special projects of longer duration than projects normally undertaken by the organization. In 1992, Ms. Everett was named the executive director for the Rebuild America Coalition, which is a broad coalition of 60 public and private organizations committed to reversing the decline in America's investment in infrastructure. Ms. Everett has a master's degree in economics from the University of Wisconsin.

Frannie Humplick is an infrastructure economist in the Policy Research Department at the World Bank. Her current responsibilities include managing research on infrastructure, keeping abreast of policy changes in infrastructure around the world, and advising governments on infrastructure expenditures and sector reform. She is an associate editor of the Journal of Infrastructure Systems and a member of various committees on infrastructure related issues. Dr.

Humplick holds a M.S. in transportation systems and a Ph.D. in infrastructure systems from Massachusetts Institute of Technology.

Bruce McDowell is director of government policy research at the Advisory Commission on Intergovernmental Relations in Washington, D.C. He has been with the commission 1963–1964, 1972–1986, and 1988-present, where his interests have included federal urban development programs, substate regionalism, regional transportation, citizen participation, the federal aid system, and intergovernmental consultation processes. On 1986-88, Dr. McDowell was on the staff of the National Council on Public Works Improvement. Dr. McDowell has lectured at numerous colleges and universities and was on the faculty of the Salzburg Seminar in American Studies in 1977 and the International Conference on Urban Planning and Economics in Beijing, China, in March 1988. Dr. McDowell is active in numerous planning and public management associations. He holds bachelor and doctoral degrees from American University and the master of city planning degree from the Georgia Institute of Technology.

Richard R. Mudge is president of Apogee Research, a firm that specializes in economics, finance, and policy aspects of public works. He is a nationally known expert in the economics and finance of environmental and transportation infrastructure. Dr. Mudge has made numerous appearances as an expert witness before the U.S. Congress and has extensive experience with infrastructure finance and the economic value of public works. He holds a Ph.D. in regional economics from the University of Pennsylvania and received his undergraduate degree from Columbia College.

Ann L. Sowder is vice president at Government Finance Group, Inc. She has more than 15 years of experience in municipal finance, including financial advisory work, underwriting, and rating agency experience. Since joining Government Finance Group in 1994, Ms. Sowder has directed and coordinated transportation-related financial advisory and consulting assignments. Ms. Sowder is a chartered financial analyst. Ms. Sowder is a graduate of the Woodrow Wilson School of Princeton University, with a masters in public affairs, and the University of Virginia, where she earned a bachelor of arts in economics.

Paul S. Tischler is principal of Tischler & Associates, Inc, a fiscal, economic, and planning consulting firm with a national practice. Mr. Tischler has been retained by dozens of public and private sector clients in roles ranging from project manager to expert witness. The firm concentrates in the following areas: fiscal impact analyses; evaluation of impact fees; capital facility

forecasting; and economic and market studies. Mr. Tischler is the chair, Economic Development Division of American Planning Association, is listed in Who's Who in Real Estate, Who's Who in Finance and Business, and Who's Who in the East. He received his MBA in real estate and urban development from American University and a bachelor of arts in economics from Johns Hopkins University.

Charles E. Williams is executive vice president and chief operating officer of Rebuild Incorporated. He is the former chief operating officer of the Toll Road Investors Partnership II where he was responsible for managing the construction of the Dulles Greenway. A retired major general of the U.S. Army Corps of Engineers, he has more than 30 years of financial and construction management experience. He is an adjunct professor of the Byrd School of Business, Shenandoah University, a member of the Board of Trustees at Shenandoah University and the Board of Directors of the Loudoun Hospital. In addition to being a graduate of both the Army basic and advanced engineering schools and the Army War College, he holds an MBA, which is supplemented by the Kennedy School of Government Senior Managers Program at Harvard University.

Deborah L. Wince-Smith is currently a senior fellow at the Council on Competitiveness, a nonprofit coalition of chief executives from leading businesses, academia, and organized labor dedicated to improving the competitiveness of U.S. industry and raising the standard of living in America. She was the first assistant secretary for technology policy in the Department of Commerce and a senior fellow at the Congressional Economic Leadership Institute, a nonprofit foundation providing a neutral forum to discuss with members of Congress and the private sector key issues affecting America's economic vitality. Ms. Wince-Smith is a member of advisory boards, councils, and boards of directors of leading national organizations and U.S. firms, such as the National Security Advisory Board of Los Alamos National Laboratory and the Association of Technology Business Councils. Trained in classical archeology, Ms. Wince-Smith did anthropological field work in Pakistan, India, and Afghanistan. She graduated Phi Beta Kappa and magna cum laude from Vassar College and received her masters degree from Cambridge University.