In the United States, the use of public-private partnerships (PPPs) has been limited. Most infrastructure projects have been undertaken by state and local governments, which have exclusively owned and operated them. However, the Obama Administration has taken steps to encourage the use of PPPs as a means of addressing significant underinvestment in infrastructure. The U.S. Treasury Department, in a series of white papers, explores the use of PPPs, provides an overview of the traditional means of financing U.S. public infrastructure, identifies impediments to the use of PPPs in the U.S., describes the conditions under which a PPP can be a better choice for an infrastructure project than conventional procurement methods and proposes new financing structures that could draw more private financing into the infrastructure market. This post highlights key elements in the Treasury papers.
The first Treasury paper, “Expanding Our Nation’s Infrastructure through Innovative Financing”, describes how state and local governments are the predominant suppliers of roads and water infrastructure and their limited use of PPPs. For example, between 2007 and 2013, transportation projects using PPPs, drew $22.7 billion in public and private funds, but that represented only 2% of overall capital investment in U.S. highways during that period. A major explanation for the limited use of PPPs has been a “well-developed municipal bond market” in the U.S.
For nearly two centuries, the municipal bond market has provided state and local governments with “low cost, tax-exempt bond financing” for infrastructure projects. Interest on municipal bonds has been exempt from federal income tax, as well as state and local income taxes in the jurisdiction where the bonds are issued. As a consequence, state and local governments have generally not needed to seek private equity financing. But, that is changing.
As public budgets at all levels of government have tightened, new sources of financing have become increasing necessary to reverse years of underinvestment in infrastructure. However, debt financing in the municipal bond market is not generating sufficient rates of return to attract the private capital needed to upgrade U.S. public infrastructure.
As a consequence, the Obama Administration is seeking ways to expand private investment and public-private collaboration in major infrastructure sectors. In 2014, it launched the Build America Investment Initiative (BAII), which includes in its aims highlighting the use of well-designed PPPs as an alternative to the public sector’s provision and management of infrastructure and associated services. The Initiative called for the Treasury and Transportation Departments to work together to find ways to increase public and private sector collaboration in infrastructure development and expand private sector financing of infrastructure projects.
A major element of the BAII was the “Fixing America’s Surface Transportation Act (FAST)”, which the President signed in 2015. That Act established a National Surface Transportation and Innovative Finance Bureau at the Department of Transportation to work with the public and private sectors to develop best practices for innovative financing and PPPs.
For its part, Treasury identified impediments to developing a more robust PPP market. One of the biggest obstacles is the “patchwork of legal environments and procurement practices across states”. As of February 2014, 33 states and Puerto Rico had enacted laws authorizing PPPs for highway and bridge projects. Even among states with PPP-enabling legislation, some are more effective in supporting PPPs than others. While just over half of those states (18) have broad enabling legislation, the others have limited or project-specific legislation. Many state agencies and legislatures lack financial expertise.
To encourage the use of PPPs, Treasury presents in its second white paper, “Expanding the Market for Infrastructure Public-Private Partnerships: Alternative Risk and Profit Sharing Approaches to Align Sponsor and Investor Interests”, three new approaches to risk and profit sharing. They are intended to expand incentives beyond the historic use of the basic user fees and “availability payments” models.
Under a “basic user fee arrangement”, the private partner in a PPP collects and retains all fees from consumers of the service, e.g. bridge tolls and payments for water bills, and bears the risk of uncertain demand for the service. By contrast, under an “availability payments” model, the government entity that is sponsoring the project collects any revenue from users and makes fixed, recurring payments to the private partner, provided the asset meets quality standards set out in their contract. Under that model, the government bears all the demand and revenue risk because it has to make the payments to the private party regardless of the level of use of the project.
As alternatives to these models, the Treasury Department proposes that government sponsors and private investors consider three new models in establishing a PPP:
- A rate of return model would limit the allowed rate of return on investment and set a regulated price that would allow the private firm to recover its costs and earn a designated return on its “rate base”.
- A price cap model, which is a variation of the basic user fee model, would set limits on the price of the infrastructure service, such as a bridge toll, but not on the rate of return. This model would protect consumers from the possibility of excessive price increases.
- Profit and risk sharing models would allow the public and private partners in a PPP to share the profits and risks. For example, if a project were to exceed or fall short of negotiated threshold rates of return, the partners could either share the excess return or absorb the shortfall in contractually defined proportions.
These new incentive structures have the potential of increasing the use of PPPs and the long-term success of PPP projects.
With its third white paper, “An Economic Framework for Comparing Public-Private Partnerships and Conventional Procurement”, Treasury seeks to “demystify” PPPs by setting out the conditions under which a PPP can be a better means of undertaking an infrastructure project than conventional procurement. Also, since PPPs are more complex than traditionally procured public infrastructure projects, Treasury has developed “best practices” that government agencies undertaking such projects with private sector partners should follow to ensure a successful PPP. They include establishing a predictable regulatory and legal environment for PPPs and implementing a rigorous project preparation process.
Jean Heilman Grier
June 14, 2016