April 11, 2008

Infrastructure Finance - April 2008

On Monday, April 7, I was in New York City, and the subject of Mayor Bloomberg’s congestion pricing became part of several conversations. The depth of the discussion was clearly driven by the outcome of the plan that failed to gain popularity amongst the democrats who ultimately refused to put the bill to a vote on the floor of the state assembly, as highlighted in an article published by the New York Times. I believe that any discussion about infrastructure finance usually is explicitly more complex than publicized with regards to whether or not the public versus the users should be taxed for infrastructure-related capital projects. However, just below the surface of any discussion about raising taxes, fees, tolls, or implementing congestion pricing is a lack of trust about whether the money raised by the government will be spent for infrastructure improvement or absorbed into general revenues.

Unfortunately, the public has good reason to distrust government spending, due in large part to the Pork Barrel Spending that often benefits the constituents of a particular politician and financed through tax payer dollars. Government accounting lacks the level of transparency that private sector has with respect to some big ticket items like the burden government has taken on with respect to public employee retirement benefits. Until the Government Accounting Standards Board (a non-profit organization recognized by both the SEC and the American Institute of Certified Public Accountants as a standard-setting body for determining generally accepted accounting principles for governments) mandated that governments had to report their unfunded retirement benefits for fiscal years ending after December 15, 2006, as Connecticut taxpayers, we did not know that the state had an unfunded retirement benefit liability of $40 billion, more than twice the annual operating budget of $17.5 billion. Earlier this year Governor Rell of Connecticut developed a plan that would authorize the sale of $2 billion in Pension Obligated bonds to reduce unfunded liability in the Teachers Retirement System.

The widespread use of earmarks diminishes public confidence in elected officials. Although some earmarks are needed because of special circumstances not anticipated in broad-based appropriations for such purposes of transportation improvements, the number and variety of earmarks give the public the distinct impression that special interests are successfully diverting significant amounts of public money away from projects of broad public interest.

The public also knows that governments routinely raid special funds or accounts created by fees or taxes when there is a shortfall in general funds. For example, although the U.S. Patent and Trademark Office has significantly increased its fees for patents and applications and needs to staff up to process significant increases in the number of applications, 20% of the fees go to general revenues.

The only sure way to protect against this raiding of special funds is to disconnect the particular activity from the government’s annual budgeting process. Special transportation authorities have been in place for decades to enable capital projects to be completed outside the pressures of the political processes to which election officials are subject. However, the public also wants to hold special authorities responsible for failing to do their job well, and the special authority structure typically does not allow that. Independent authorities are accountable to the bondholders, While their boards of directors are political appointees, typically the appointment processes are deliberately designed to insulate the boards as a body from short-term political pressures.

Governments can create obstacles to future actions that minimize the likelihood of changing a direction in a way that breaks faith with the commitments made to voters. For example, the Congress came up with a creative solution to the problem of closing military bases. They formed a Base Closing and Readjustment Act Commission, which would make a package of recommendations about base closures. Congress agreed that the Commission’s recommendations could only be approved or disapproved as a package, which took individual congressmen off the hook with respect to bases in the members’ districts. It’s not easy to make a decision that is substantially irreversible, but we need to build confidence that strategic decisions made in accordance with the wishes of voters will not be overturned by intense short-term political pressures.

The biggest challenge elected officials have in front of them today at all levels is to rebuild public confidence that they can spend money wisely. Transparency is essential, particularly with respect to both big unfunded liabilities. Earmarks probably cannot be eliminated, but they need to be significantly reduced. Finally, governments need to commit to strategic objectives and to create barriers to diverging from them. Short-term political or financial pressures should not be an excuse to raid a special fund, or to reverse direction on a strategic priority.