Unlocking America's Infrastructure: Incentivizing Private Investment

Congress should redirect infrastructure funding to lift the cap on Private Activity Bonds (PABs), while implementing stronger standards for qualifying public-private partnerships

Based on the sheer volume of federal legislation, we should be experiencing a golden era in U.S. infrastructure. Between November 2021 and August 2022, Congress passed the massive Bipartisan Infrastructure Law (BIL), the CHIPS and Science Act, and the Inflation Reduction Act. Together those laws authorize about $1.7 trillion in spending and constitute the largest federal action on infrastructure since the National Interstate and Defense Highways Act of 1956. The three acts were touted as landmarks that would strengthen the country’s infrastructure and address endemic problems such as protracted underfunding and a backlog of deferred maintenance.

And yet the United States remains bedeviled by chronic infrastructure problems. Aside from their poor condition, many aging bridges, such as the Key Bridge in Baltimore, are ill-prepared for collisions with increasingly large container ships. As the 2022 water treatment crisis in Jackson, Mississippi revealed, many drinking and wastewater water systems are old and prone to failure. The country’s grid is strained by growing power demand from AI and data centers as well as the challenges associated with renewable power sources, which are inherently variable, such as wind and solar.

Cost overruns for new projects are common. Phase 1 of New York’s Second Avenue Subway, for example, ended up costing about $2.5 billion per mile. That is 8 to 12 times more expensive than similar subway projects in Paris, Berlin, and Istanbul, as well as in Sweden and Italy. The cost of California's high-speed rail (HSR) project has nearly quadrupled since construction began in 2016 and is now estimated to be over $128 billion. The cost of the 171-mile segment between Merced and Bakersfield alone is more than $35 billion, higher than the original budget for the entire 800-mile project.

U.S. infrastructure has seen some successes, however, as some important new infrastructure facilities are coming online. The Brightline East rail in Florida, which runs between Orlando and Miami, opened its Orlando station in September 2023. The $900 million Pennsylvania Rapid Bridge Replacement program, which wrapped 558 structurally deficient rural bridges into one contract and quickly replaced them, was completed in January 2019 in under four years. Los Angeles International Airport’s Consolidated Rent-A-Car Facility (or ConRAC), which is expected to become operational in 2025, will be able to store almost 21,000 rental vehicles.

What do these diverse but successful projects have in common? The answer is a reliance on Private Activity Bonds, or PABs, as a financing tool. A PAB is a debt instrument that allows private entities to receive the same tax treatment as municipal bonds for projects that have a public benefit. That treatment makes the interest income on the bonds exempt from taxes at the federal level, which leads to bond investors accepting a lower interest rate to hold those bonds. PABs thus allow private entities to benefit from the lower financing costs of tax-exempt municipal bonds.

PABs are important because they help privately issued bonds to compete with their municipal-bond counterparts, which have existed since the Revenue Act of 1913. Private companies don’t have that tax advantage unless they receive a PAB authorization from state and local authorities, which helps to level the “cost of capital playing field” between public and privately issued debt.

If the tax code discriminates against private financing of U.S. infrastructure, several key benefits are lost. Most of all, private finance is one of the cornerstones of public-private partnerships, or P3s. P3s have the potential to bring American infrastructure delivery up to global standards through better cooperation between the public and private sectors. As we discuss below, P3s are popular and successful in many other countries.

The central aspect of a P3 is that it bundles or “wraps” the design and construction of a piece of infrastructure together with its operation and maintenance over the long term, such as 25 or 30 years. Such a P3 might also include private-sector financing to cover the new infrastructure facility’s substantial design and construction costs, known as a DBFOM (Design-Build-Finance-Operate-Maintain) contract. It’s possible to have the operation and maintenance advantages of P3s without direct private financing, but the risk-spreading and risk-management advantages of private-investor participation are then absent.

Today many roads and bridges that were built in the 1960s and 1970s could benefit from technology and innovations that did not exist at the time. Since P3 contracts include long-term operation and maintenance, there's a risk of locking in outdated technologies unless the contracting process anticipates future advancements. Such improvements must be incorporated into the new structure’s design and construction, as well as its operation and maintenance, by “future proofing” the contracts that the public sector strikes with the private sector. A future-proofed contract places that risk of not adopting innovative technologies and design standards well into the future on the private partner, thus ensuring that private capital, incentives, and expertise are deployed to make U.S. infrastructure as resilient as possible for decades to come.

A properly structured P3 contract also puts the risk of time and cost overruns on the private partner rather than on the taxpayer. The private partner can be incentivized to deliver the project on time via financial penalties for late delivery and rewards for delivery ahead of schedule. Evidence suggests that projects led by private entities often come in either on time or ahead of schedule.  In an exhaustive review of the empirical evidence on P3s, Stefan Verweij, Ingmar van Meerkerk, and Carter B. Casady (2022) show that while publicly funded projects tend to struggle with inefficiency and cost overruns, P3s are more likely to succeed, delivering timely and financially sustainable projects.

Congress has recognized these benefits and to some extent encouraged them in the recent laws. Aspects of the 2021 BIL encourage greater private-sector participation in U.S. infrastructure delivery. Section 80403, for example, increases the national limit on Private Activity Bonds (or PABs) for qualified highway or surface freight transportation facilities from $15 billion to $30 billion, which is laudable. But it doesn’t go nearly far enough. We argue that the cap should be substantially increased.

With trillion dollar deficits as far as the eye can see, one obvious question is the cost of such an increase. Since the U.S. Treasury only loses the tax on the interest on such bonds, and those national limits refer to the principal amount, at most the Treasury loses around 41% (top marginal rate of 37% plus the 3.8% Medicare surtax on investment income) of the interest each year. That interest itself is much lower than the interest on taxable bonds due to the demand for tax-exempt bonds by taxable investors. Even assuming an after-tax rate of 5%, each $100 billion of PABs outstanding only loses the Treasury around $2 billion per year (41% of the $5 billion interest).

Furthermore, if the newly issued PABs end up replacing public municipal bonds that would have been issued anyway, the cost is smaller by however much they replace. And if they replace large direct federal spending in infrastructure bills, their cost to the government is further reduced. Ideally unused funds from some of the massive infrastructure bills could be reallocated for this purpose so as not to incur any further costs.

Beyond the expansion of PABs, more can be done to encourage greater private involvement in U.S. infrastructure delivery, which would help address several stubborn problems we face today. Now is the time to start thinking about policies to include in the next highway reauthorization bill, which will begin to take shape soon, as the current authorization was part of the BIL and only runs through fiscal year 2026. Indeed, the present moment offers an opportunity for the private sector to take on a larger role in providing infrastructure financing beyond what can be provided by the federal government.

Congress could take additional steps to facilitate both greater and more successful use of P3s in the United States. The challenge with U.S. P3s is not only that there are too few but that there is a risk that ill-informed state or local government negotiators might be at a disadvantage relative private investors’ legal and consulting teams.  P3 contracts may not adequately protect the public interest as a result and may omit such key considerations as future proofing.

One measure Congress could take alongside a PAB expansion that would improve both the quantity and quality of P3s is to incentivize states and regions to utilize “P3 units.” P3 units are quasi-governmental entities that assist the public sector with pre-project screening, project prioritization, education, and expert advice. P3 units have been established in Australia, Canada, China, Israel, Japan, Egypt, the United Kingdom, and India, among many other countries.

P3 units have contributed to the impressive infrastructure accomplishments in many jurisdictions, including Washington DC’s Smart Street Lighting Project, where its Office of Public-Private Partnerships (or OP3) assisted, and the I95 Express Lanes project in Northern Virginia, where Virginia’s Office of Public-Private Partnerships (or VAP3) assisted.  P3 units strive to ensure that infrastructure projects attract private participation while promoting the public interest. Despite their global popularity, P3 units remain relatively underused in the United States. P3 units have effectively supported private participation in infrastructure around the world, as the World Bank has noted.[1]

Because the U.S. lags other developed countries in P3 use, the benefits of such units would likely be large if implemented here. To encourage P3 units, certain federal funding to a state or region for infrastructure could be conditioned on the state having a P3 unit. Even better, qualification for PAB allocations under the incremental additional amounts between the new ceiling and the old ceiling could be conditioned on the public partner having a qualifying P3 unit.

In recent years the U.S. has spent a great deal of taxpayer money on infrastructure bills but has much less infrastructure to show for it than it should. At a time when other countries are surging ahead with modern infrastructure, the U.S. cannot afford to let outdated financing models hold it back. Although it is important to guard against the risks of poorly structured infrastructure deals, the solution lies in setting conditions for stronger partnerships, not in discouraging or limiting the role of the private sector. Congress could make considerable progress by relaxing the dollar limits on PABs while simultaneously implementing qualification criteria that strengthen the quality and public benefit of P3 projects.

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[1] See “Public-Private Partnership Units,” World Bank (2007). chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://documents1.worldbank.org/curated/en/220171468332941865/pdf/431390REPLACEM0te0partnership0units.pdf