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Policy Memo
January 11, 2008
The Case for General Obligation Bonds to FinanceBridgeand Highway Construction
by David Strom, President, MinnesotaFree Market Institute
CURRENT PRACTICE: Pay as you go for roads and bridges, for both maintenance and construction. Funds come primarily from user fees such as motor fuels tax, tab fees, motor vehicle sales tax, or in some rare cases debt paid through the Trunk Highway Fund.
PROPOSED CHANGE: Rely more heavily on general obligation bonding for roadway enhancements and construction; use pay as you go primarily for maintenance.
RATIONALE: Pay as you go seems like sound fiscal practice, but it in fact only makes sense as a method for paying for current consumption expenditures.
Long-term capital investments for projects that will yield benefits over numbers of years should generally be funded using long-term debt obligations (bonds) as long as the expected value of the return on investment outweighs the expected obligations over the lifetime of the bonds.
Using bonds to pay for road construction is based upon the same principle as using a mortgage to pay for building a house or businesses taking out loans for capital investments. Instead of accumulating the capital for building a house over 30 years, or building the house one bit at a time over an extended time frame, it makes more sense to borrow money to build the house and pay for it over its useful lifetime. Homeowners pay for the house as they enjoy its use.
Businesses use the same principle when they borrow money for capital expenditures that will provide payoff over an extended period time. As long as the benefits anticipated exceed the costs of paying off the debt, it is more rational to incur the debt in order to obtain the benefits. Often businesses could not afford to operate or expand if they did not obtain capital in the debt markets to fund investments in future productivity.
Most Highway and bridge projects have an expected lifespan of 30-50 years, and sometimes in excess of 100 years. And it is the rare highway or bridge project that does not provide benefits that far exceed the costs of the initial investment. Hence it makes sense to pay for the public benefits of the projects over a period of 20 years.
BENEFITS: Using State General Obligation bonding authority to fund major infrastructure projects has many advantages over the current funding system, which relies on a pay-as-you-build system:
1) The current system requires accumulation of enough capital to build an entire project before it can be built; or alternately, it requires that projects be done on a piecemeal basis, long delaying the full benefits of a project’s completion.
2) The pay-as-you-go system requires current users to pay for benefits that may or may not occur in the distant future, rather than for the current use of the system.
3) Using bonds allows policymakers to bring forward future benefits into the present by paying for projects up front with borrowed dollars, and in the case of projects with projected benefits substantially in excess of their costs (which is usually the case with transportation projects), the dollars saved in accumulated benefits will far outweigh interest costs.
4) Using bonds facilitates efficiencies, such as design-build construction on shortened time frames.
It is not uncommon for states to use General Obligation bonds to fund road and bridge projects, and the National Council of State Legislatures recommends the use of G.O. bonds as additional source of revenue to meet transportation funding needs.[1]
Questions and Answers
Does using the General Obligation bonding capacity of the State crowd out other, more important expenditures for a public purpose?
The Capital Investment bill is rarely dominated by, and never exclusively consists of high value-added spending that constitutes investments in long-term state resources. While a substantial portion of any bonding bill will include legitimate capital expenditures such as building acquisition or renovation, the bonding bill commonly includes frivolous and low-priority spending that would never pass muster under a rigorous cost-benefit calculation for state purposes.[2]
A short list of some of the projects proposed for the current bonding bill include: a ski jump in Bloomington; forgiveness of the state loans for the RiverCenter and the Target Center ($137 million combined); money for the Duluth Convention Center ($40 million) and the Rochester Civic Center ($37 million); a Polar Bear exhibit at the Lake Superior Zoo, a fish habitat display at the State Fair; and a National Volleyball Center in Rochester. Most bonding projects have benefits that are primarily local in nature. None of these projects can legitimately claim that their benefits exceed those that would be provided by strategic investments in our transportation infrastructure.
It is difficult to argue that ski jumps and polar bear exhibits are higher value-added investments than General Obligation bonding for our highway system. Given the unanimity that exists that our road and bridge infrastructure are under-funded, politicians should first look to the allocation of existing available resources and put them to their highest, best use.
Is the use of General Obligation bonds for trunk highway purposes legal?
Bond counsel Dorsey and Whitney[3] has been asked this question and cannot give an unequivocal answer, suggesting that the issue might have to be resolved by the Supreme Court. However, the plain language of the Constitution supports an interpretation that the use of G.O. bonds would indeed be perfectly consistent with the intent of the Constitution’s Framers:
The Minnesota State Constitution reads Article XI, Section 5, clause (a):
Sec. 5. PUBLIC DEBTANDWORKS OF INTERNAL IMPROVEMENT; PURPOSES. Public debt may be contracted and works of internal improvements carried on for the following purposes:
(a) to acquire and to better public land and buildings and other public improvements of a capital nature and to provide money to be appropriated or loaned to any agency or political subdivision of the state for such purposes if the law authorizing the debt is adopted by the vote of at least three-fifths of the members of each house of the legislature;
State highway expenditures would certainly seem to fit under the criteria set out: “public improvements of a capital nature.”
The precedent for using G.O. bonds for transportation purposes has already been set. The state portion of the Hiawatha Light Rail line was paid through bonding.
Should the state just pile up debt to address the backlog in transportation funding?
Legislators currently work under the recommendation that debt obligations should not exceed 3% of general fund expenditures. Using this figure, the 2008 bonding bill will likely top out near $1 billion in new spending. The Minnesota Free Market Institute strongly supports limiting debt expenditures to a reasonable standard, and hence recommends that Legislators not exceed the 3% recommendation.
QUESTION: Are the resources available through using general obligation bonding enough to address our transportation needs?
This is a question that is impossible to answer without taking a synoptic view of the highly complex problems we face. Transportation funding decisions are made in a complex context that includes necessarily limited resources, competing needs for funding, highly variable costs and benefits of different investments, and highly political disagreements about land use and preferred transportation modes.
What we can say is that by tapping into the resources available through general obligation bonds we can immediately divert resources from low-value public investments into higher-value transportation projects. Once we have tapped into available public resources that are now diverted to lower-priority spending, we will at least be in a better position to determine, what, if any, additional resources should be devoted to transportation funding.
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