Many central, provincial and local governments raise private capital for infrastructure development by issuing bonds. In many cases, the bonds are issued by the regional authority seeking to raise the capital, the interest payable on the bonds offers some form of tax exemption and the obligations of the issuing authority are fully or partially supported by central or provincial government guarantee.58 Australia has used infrastructure bonds in the past and they are widely used in the United States, Canada, New Zealand, Chile, Malaysia and by members of the European Union. Several countries issue generic state bonds that are applied to infrastructure projects, amongst others (Sweden and Germany).
Developed economies with established capital markets trade infrastructure bonds in competition with traditional public and private bond issues. In developing economies, small or inefficient capital markets, unstable exchange rates, high rates of interest and sub-investment grade sovereign credit ratings limit the opportunity for this form of investment capital. Nevertheless, countries that have issued infrastructure bonds to develop domestic capital markets include Kenya and India.
In Australia, the Commonwealth Government introduced an infrastructure borrowings taxation scheme in 1992 which was designed to stimulate private investment in infrastructure with a tax exemption of interest derived from qualifying loan facilities. 59 The program was modified and extended in 1994 as the Infrastructure Borrowings Taxation Concession and replaced in 1997 with the Infrastructure Borrowings Tax Offset Scheme. The latter
program was limited to large scale land transport projects and the largest and last major infrastructure project to take advantage of bond financing in Australia was Transurban Group's Citylink tollway in Melbourne. These programs granted a tax benefit to secured private lenders but not the unsecured risk-taking equity investors. It followed that the scheme was mainly employed by promoters to develop hybrid tax advantaged debt securities for high net worth individual investors. The scheme was phased out in 2004.
The United States has long supported tax exempt bonds as a method of raising private infrastructure finance for state and local governments. The US legislative framework has been subject to many changes over the past 20 years and in its current form, legislation authorises state and local governments to issue tax exempt bonds for investment in ports, urban transport, public schools, waste management systems, energy, water, intercity rail services, public housing and airports. Critics of this approach argue that tax-based infrastructure is inefficient for the following reasons:
• The low equivalence between the tax benefit granted to corporate and high net worth individual investors and interest savings to state and local governments (average marginal tax rate saving 35.7% and interest rate savings of 1.80% per annum)
• The tax exemption to investors with high marginal rates of tax fails the test of Pareto efficiency
• The arrangement operates as a transfer payment to state and local governments together with authority and discretion to issue what is, in effect, a federal government tax handout
• The extension of the program to quasi-social infrastructure such as sports stadiums and public entertainment facilities
• Eligibility for the tax exemption is denied to lending institutions, public and private pension funds and institutional investors.60
The Role of Taxation
The infrastructure bonds employed in developed economies generally employ a taxation concession in the form of a full or partial interest exemption (or rebate). Tax-based incentives present a conundrum for government. If investment is advantaged with an exemption, there is an explicit transfer payment from the state to the private investor. First, funds raised by the state will be invested in public goods that deliver welfare and private benefits.61 Second, the security will be priced at a discount to other state securities in the market. This may reflect the lower risk of state bonds or simply that buyers recognise the real post-tax return of the bonds and adjust for the tax benefit.
Alternatively, the bond may be indexed in which case there is a discount in the yield spread (or interest) that is paid to retail investors. In both cases, there is an advantage to government in that the infrastructure security is generally priced at a lower rate than other bond issues in the market.62
The benefit cost analysis for this approach is as follows:
B = W - (C + D)
Where:
B is the net benefit to the state
W is the welfare and private benefits
of the investment
C is the cost of transfer payment
D is the deadweight cost.
The role of dedicated infrastructure bonds in project procurement remains contentious particularly if the bond is offered with tax exempt status. Nevertheless, it remains an option. The challenge for government in following this path to infrastructure provision is to undertake a cost effectiveness comparison between the different funding options available to it after adjusting for the distortions and adverse economic outcomes of each particular approach.
__________________________________________________________________________________
58 Alternatively, the bond may be issued by a Treasury or Treasury Corporation that has the advantage of a better credit rating which attracts a lower cost of capital.
59 Income Tax Assessment Act (Cwlth) 1936, Division 16L; Land Transport Infrastructure Offset; Income Tax Assessment Act 1997, ss. 40-830 to ss. 40-885.
60 Regan 1999.
61 Hillman 2003, p. 131-138; Abelson 2003, pp. 404-418.
62 Chan, Forwood, Roper and Sayers 2009, p. 84.