Infrastructure Plan: A Third Option
David R. Kotok
September 19, 2011
President Obama proposed $447 billion in a package designed to stimulate infrastructure spending and project-oriented job creation in the United States. House Speaker Boehner and House Republicans will offer an alternative plan. These plans then go through super-committee negotiations that are attempting to design a budget-deficit, spending, tax-management proposition in a much divided Congress.
The outlook for any of the elements offered to lead to a successful compromise is considered bleak by many Washington observers. However, we want to place another option on the table, along with a concise way to pay for it without expanding the Federal deficit.
Rather than a mixed package of $447 billion, we propose $535 billion in a five-year program to be allocated to infrastructure spending. The mechanics of this program are via Build America Bonds, a proven and tested method of infrastructure finance.
You may be asking yourself: why the number 535? That is the exact number of Senators and Representatives that comprise our Congress. If they vote no, they will each be taking responsibility for voting against one billion dollars of infrastructure spending.
We further propose that the monies be distributed among the fifty states in proportion to the number of Senators and Congressmen in each state. Therefore, a small state with one Congressman and two Senators would receive an allocation of $3 billion of Build America Bonds. A larger state with ten Congressmen and two Senators would receive an allocation of $12 billion in Build America Bonds.
For what would the money be used? We propose that it must be spent on infrastructure, construction, and municipal development projects. Think of it as a way of funding schools, airports, sewer and water plants, toll roads, and bridges – all that is in the purview of government.
Who would determine what projects would be undertaken? Existing local and state-level agencies would decide their needs and how to structure their own projects. If a town needed a water company, they could use a Build America Bond to finance it. If a district needed a new school, they could do the same.
Fortunately, the structure would be the same as the Build America Bonds we already know. The Federal government would pay 35% of the interest in the form of a rebate to the issuer of the bonds. We already have close to $200 billion of Build America Bonds issued. The disclosures and techniques in order to finance them are established, so there is no need to form a new federal agency, allocating to other agencies. A federal presence is not required, other than to define the use for which Build America Bond proceeds may be applied.
Would this create more federal deficits? Yes, if it was standalone, but we propose an alternative to pay for it. The interest subsidy on a Build America Bond at current market prices is somewhere around 1.5% per year. It works like this: a tax-free bond could be sold in conventional terms, and the buyers of such bonds would be limited to high-tax-bracket, wealthy Americans. Build America Bonds, on the other hand, are taxable instruments to the bond buyer. They are not tax-free municipal bonds, but the Federal government rebates a portion of the interest to the issuer of the bond. So, the issuer of the bond makes a decision as to which method is less costly when it issues bonds. Does it use tax-free bonds? Does it use taxable bonds? Whichever one results in the least expensive finance is the one that is preferred.
So, how would the interest-rebate portion be paid out of the Federal budget? The answer here is simple: repeal the ethanol subsidy, which is approximately the same amount of money as it would take to have a half-trillion-dollar Build America Bonds program. The Congressional Budget Office (CBO) would score ethanol subsidy and Build America Bonds at about the same amount of money per year for the next, say, thirty years.
What would happen if you stopped the ethanol subsidy? You would use that money instead to rebuild the infrastructure of the United States. You would stop driving up corn prices. You would free up almost half the corn crop, which is currently going into ethanol, and instead let it be applied for food. If ethanol remains economically viable because of the mandate that requires it to be part of the fuel system, so be it. If not, then there will be changes in different types of ethanol-like products. Even the most intense supporters of the ethanol subsidy admit that when the oil price is approximately $100 a barrel, the need for a subsidy for ethanol is really not justified.
Why five years instead of two, like the original BABs program? It takes time to plan infrastructure projects. If the project were approved tomorrow, for example, the school board would need to hire architects, contractors, and workers. It would have to go through the process of determining what type of school to build, how it would be built, and enter the process of bidding and construction and permit applications. The same would be true for the sewer plant upgrade or the reconstruction of a bridge. Infrastructure is a long-lead-time activity.
Would this create jobs right away? The answer is yes! Most projects create jobs immediately, because engineering firms, designer firms, architectural firms – those who do the preliminary work on a project – get employed quickly. The evolution of a project takes place over several years. Would it create the million jobs that the Obama administration says are needed to rebuild the infrastructure of the United States? We do not know, but we do know what we have seen with Build America Bond-financed projects. We have acted as a financial advisor on a number of them, and we have determined from our experience that many construction, project, and infrastructure-related jobs result from them.
Would state and local governments have to use the Build America Bonds money? Absolutely not. This is not a wasteful program; it is an optional program. The money is available; the rerouting of ethanol subsidy money to Build America Bonds is there. The allocation goes to the states, and the states determine their level of participation.
Will these bonds stand on their own credit, since the Federal government is not guaranteeing the bond principal? The answer here is yes. Market-based credit analysis and revenues have to be allocated to amortize the bonds – all that goes into the mix of each specific bond project. Each project must stand on its own merit. It must have the revenue, support, and economic research. This gets packaged into an official statement that can be presented to bond investors, who will determine on their own if they want to take the risk and buy this bond.
Who will buy these bonds? Build America Bonds are taxable securities. Therefore, they become desirable for pension plans, IRAs, institutions, charitable foundations, banks, and others who are seeking investments at yields that can justify those investments and who at the moment are thirsting to find them. In addition, foreigners will buy Build America Bonds. We saw that in the last round of BABs, when foreign buyers came into the market and started to participate in this form of finance.
In summary, here is our proposition. No Federal deficit impact. Repeal ethanol subsidy. Reallocate ethanol subsidy to an interest subsidy in the Build America Bonds program. Launch the Build America Bonds program with a five-year time horizon. With the size of $535 billion, we can easily convince Washington that the math is simple. In Washington, if it is not simple it does not have a chance. That would enable each Congressman to stare down a vote of a $1 billion allocation for his or her state. A concise program that creates infrastructure spending, puts the incentives to do it where they belong, and allows for independent credit analysis, could be implemented immediately and does not interfere with the super-committee’s work or any other committee’s work. This is our option to rebuild the infrastructure of the United States.
David R. Kotok, Chairman and Chief Investment Officer