Preparing states, cities and the transportation sector for federal insolvency

Many transportation organizations seem to be assuming that the federal funding levels of the Infrastructure Investment and Jobs Act (IIJA) legislation will be the new baseline in the 2026 reauthorization of the Highway Trust Fund. For example, the American Society of Civil Engineers recently reported that not renewing IIJA would cost the U.S. economy $637 billion in worse infrastructure.

For the past year, the American Road and Transportation Builders Association’s (ARTBA) magazine has featured articles about projects funded by IIJA grants. But at the annual ARTBA public-private partnership (P3) conference in July, senior staffers from both the House and Senate appropriations committees expressed doubt that the higher funding baseline would happen, surprising many of the attendees.

Contrary to the views of many transportation colleagues, I was cheered by this prediction, and here is why. The main reason is that the U.S. government is facing a monumental fiscal crisis a decade from now. The Social Security Administration’s trustees expect the system’s trust fund to be exhausted in 2035. This means Social Security could pay benefits based only on annual Federal Insurance Contributions Act (FICA) revenues, which would require a benefit cut of up to 20%.

The following year, the Medicare Part A trust fund is likewise forecast to run out of money. Annual outlays from these two programs total $2.1 trillion, so if Congress has to make up 20% of their annual outlays, that would be $420 billion in new federal spending.

With the national debt already exceeding 100% of gross domestic product (GDP) and projected by the Congressional Budget Office (CBO) to continue rising, Congress should focus on reducing federal spending, not increasing it even more by additional borrowing, thereby further increasing the national debt.

All three major credit rating agencies—S&P, Fitch, and Moody’s—have downgraded the federal government’s credit rating, and they may issue further downgrades if huge annual federal budget deficits continue to add trillions more to the national debt each year.

Just to ensure we’re all on the same page, remember that in recent years, general fund bailouts of the federal Highway Trust Fund (HTF) have totaled $275 billion—all of it borrowed, adding to the national debt.

IIJA was funded entirely by borrowing $550 billion, of which $209 billion is allocated to highway and transit grants. When the next president and Congress take office in Jan. 2025, they should cease bailing out the Highway Trust Fund and reject calls to enact a second Infrastructure Investment and Jobs Act.

But what about America’s aging, obsolete bridges, our aging Interstate Highway System that needs reconstruction and modernization, and other infrastructure improvements?

Almost all vital infrastructure is owned and managed by state and local governments. For facilities such as airports and highways, owners can issue long-term revenue bonds to finance new capacity expansion projects and reconstruction efforts. They also have increasing opportunities to utilize long-term public-private partnerships using a mix of private equity investment and long-term debt financing (for either revenue-risk or availability-payment financing).

The difference between federal borrowing (for HTF general-fund bailouts and programs such as IIJA) and state borrowing is that states have constitutional requirements to operate with balanced budgets. State and local government borrowing must be backed by a facility’s revenue stream or the state or locality’s tax base. Of course, this constraint on the extent of their borrowing is significant, but it provides some incentive to select projects that make economic sense.

The kind of shift I’m talking about is a way to safeguard much-needed infrastructure investment against the genuine threat of federal government insolvency. Based on CBO projections, the country has about 10 years to get this transition underway prior to Social Security and Medicare reaching insolvency. When their trust funds are exhausted, Congress’s top priority will likely be to prevent benefit cuts to the programs’ combined $2 trillion annual spending.

Nearly all other long-standing federal programs could face significant spending cuts at that point. Some cuts will likely be enacted in haste as lawmakers are forced to confront the entitlements emergency.

Infrastructure organizations, including state departments of transportation and metro area transit agencies, need to start thinking about, planning for, and implementing self-help measures to reduce and perhaps eliminate their dependence on federal funding. Those state governments that have established rainy day funds would do well to expand them over the next decade as part of their preparation to take over more responsibility to pay for their needed infrastructure.

This is not a brand-new idea. One policy discussed, largely in-house, by the Reagan administration in the 1980s was devolving many federal functions to state and local governments.

A decade later, the idea of devolving many functions to state and local government caught on, stimulated by Brookings Institution scholar Alice Rivlin’s 1992 book, “Reviving the American Dream.” Organizations such as the Eno Foundation held conferences on devolution. David Luberoff of the Harvard Kennedy School argued that federal transportation programs should be devolved to the states. 

After speaking at several such conferences, I wrote a 1996 Reason Foundation policy study, “Defederalizing Transportation Funding.” That effort got as far as a highway funding devolution bill from then-Sen. Connie Mack (R-FL) and then-Rep. John Kasich (R-OH). Over two years, the bill would have phased out all but two cents of the federal gasoline tax, with the remaining two cents for roadways on federal lands and Indian reservations, plus some Federal Highway Administration oversight. The bill also had strong support in California, including from then-Gov. Pete Wilson and the state’s 1996 Commission on Transportation Investment. Even the head of the American Association of State Highway and Transportation Officials in 1995 supported a significant shift from federal to state funding.

Thus, this idea has a history and was able to obtain significant support from key transportation players when there was reason to question the status quo, which at that time was often talked about as “donor vs. donee” states.

Today, the national debt and the impact the looming insolvency of entitlement programs will have on federal transportation spending are good reasons to question the transportation funding status quo.

A version of this column first appeared in Public Works Financing.

The post Preparing states, cities and the transportation sector for federal insolvency appeared first on Reason Foundation.