States historically have funded transportation projects by paying for construction, maintenance and administration as money became available from user fees and federal grants. States also have financed projects by assuming debt that could be paid back by state funds, and this trend has accelerated. Bonds typically are repaid by gas taxes and other state revenue. In the last several years, however, more states are turning to bond financing for transportation projects as a way to speed project delivery. This has occurred in part due to greater availability of "innovative" financing techniques promoted by the federal government, as noted elsewhere in this report. While only 26 states used bond proceeds to pay for highway projects in 1998, 34 did so in 2003.15
Bond financing has several advantages. Selling bonds allows governments to spread the cost of transportation infrastructure over time so that both present and future users share the cost. A key benefit is that bonds allow governments to construct large projects more quickly than if financed through traditional methods. As a recent South Carolina transportation funding report notes, "If governments had to wait until all federal and state funds necessary for a particular multiyear project were available, large amounts of money would be underutilized and construction would move slowly. Bonding allows governments to capitalize future cash flows today in order to obtain needed funds up front and then slowly repay them over the project's lifetime."16
In addition, by obtaining and spending large portions of project financing in one time frame, state agencies can somewhat mitigate the problem of project budgets increasing in response to rising construction prices. A recent example of this is in New Mexico, where the cost of the $1.6 billion transportation program endorsed by the Legislature in 2003 is expected to increase by $60 million due to rising construction costs.17
The use of debt financing for transportation has skyrocketed in the last six years. As table 3 shows, outstanding state obligations for highway indebtedness grew 75.4 percent between 1998 and 2004. As of 2004, eight states-Idaho, Iowa, Montana, Nebraska, North Dakota, South Dakota, Tennessee and Wyoming-had no outstanding debt, according to the Federal Highway Administration Finance Series.18
Table 3. State Outstanding Debt, 1998-2004 | ||||
| Year 1998 2004 | Obligations Outstanding $45.9 billion $80.5 billion | Percent Increase
75.4 | Number of States 39 (plus D.C.) 41 (plus D.C.) |
Source: Federal Highway Administration Highway Finance Series for 1998 and 2004, Table SB-2. | ||||
The use of bond proceeds to pay for highway projects has likewise increased dramatically in just five years. As table 4 shows, the use of bond proceeds rose from $6.1 billion in 1998 to $9.5 billion five years later, an increase of 55.7 percent. This compares to an overall increase in total user tax revenues for state highway projects of 7.9 percent, from $40.5 billion to $43.7 billion. The use of bond proceeds increased seven times faster than user tax revenue. Part of this growth was due to the fact that 12 additional states used bond proceeds, while five states who used bond proceeds in 1998 Georgia, Hawaii, Michigan, Mississippi and North Carolina did not in 2003.19
Table 4. Bond Proceed Growth, 1998-2003 | ||||
| Year 1998 2003 | Bond Proceeds $6.1 billion $9.5 billion | Percent Increase
55.7 | Number of States 26 34 |
Source: Federal Highway Administration Highway Finance Series for 1998 and 2003, Table SF-21. | ||||
Finally, the cost for retiring bonds grew fast as well. Thirty-nine states and the District of Columbia paid bond retirement costs of $2.9 billion in 1998, compared to $4.7 billion in 2004, an increase of 62 percent (table 5).
Table 5. Bond Retirement Cost Growth, 1998-2004 | ||||
| Year 1998 2004 | Bond Retirement Costs $2.9 billion $4.7 billion | Percent Increase
62.1 | Number of States 39 (plus D.C.) 40 (plus D.C.) |
Source: Federal Highway Administration Highway Finance Series for 1998 and 2004, Table SB-2. | ||||
Although bond financing (and other debt instruments) help accelerate transportation projects and are an important tool in the mix of financing mechanisms, there are drawbacks. The funding received is not new money and has to be repaid with interest into the future. This can potentially take funding away from other vital projects in the future. The legal instrument used to obtain bond proceeds obligates the state to repay interest and principal before other less senior obligations and priorities.
New Jersey has faced problems because its obligations for debt repayment have overwhelmed available funding. The state's Transportation Trust Fund (TTF) was projected to be empty by July 2006, based on existing debt obligations, unless the Legislature acted to replenish the fund.20 Among the proposals considered to increase revenue were refinancing existing debt, potentially raising the 14.5 cent gas tax, increasing turnpike tolls and transit fares, and stopping the annual diversion of $115 million in TTF monies to the general fund.21 At publication a final deal was still in negotiations.
As noted, several states do not use debt financing for transportation projects. State legislatures that are interested in this option will want to consider the need for legislation to remove barriers for issuing certain types of debt and to ensure efficient debt management. Creation of a debt management policy and statutory debt limit are possible approaches. To avoid the problem that New Jersey and other states are facing, state policy should ensure that adequate revenue is generated to pay for maintenance and operation of the transportation system in addition to debt repayment. A specific debt management policy and debt limits are tools to assist legislatures exercise discipline in the use of debt for transportation purposes.