For institutional investors who have been stymied in their desire to invest in infrastructure, the Trump administration's plan to build $1 trillion of infrastructure sounds promising. This is especially true because the plan appears to rely on equity investment.
The plan, as outlined in October by Wilbur Ross (now nominated to be Secretary of Commerce) and Peter Navarro (now head of the White House National Trade Council), relies on a likely capital structure of 83% debt and 17% equity (5:1 leverage). But the federal government would provide an 82% tax credit to the equity investors, making their net investment 3%. In other words, 14% of the investment would come as a no-cost payment to the equity investors from U.S. taxpayers.
No doubt, institutional investors would like some of that action. But they shouldn't get their hopes up. The Ross-Navarro plan is unlikely to provide them with substantial new investment opportunities.
First, the impediment to infrastructure investment is not a lack of capital, so a plan focused on increasing capital availability is likely to result in little new infrastructure.
State and local governments raised a record $445 billion in 2016 through the issuance of bonds in the municipal bond market. And they did so at near-record-low interest rates. The state of California raised 30-year money at 3% in a multibillion-dollar financing in September. Such low interest rates certainly don't suggest there's a shortage of capital.
The Ross-Navarro plan requires $167 billion of equity capital over 10 years. While they describe that as “obviously a daunting amount,” it's a mere $3 billion net amount per year after the tax credit (an amount the muni bond market raises every two days!)
How much can institutional investors beef up their infrastructure portfolio if they all battle over a mere $3 billion of opportunity every year?
The abundance of cheap capital points to the real reason we don't invest enough in infrastructure. There's a lack of projects backed by a reliable revenue stream (either tax revenue or user fees).
No one provides capital for free. Equity capital under the Ross-Navarro plan would expect a 9% to 10% return and debt investors would expect 4.5% to 5% (too low to be of interest to pension funds).
So, unless we rely entirely on federal deficit spending, politicians must ask citizens to pay more if investors are to be repaid and we're to build more infrastructure. But does the new president propose, for example, raising the federal gas tax that's been frozen for several decades? No.
A second problem for institutional investors is that the Ross-Navarro plan doesn't address the reason that government, when it builds infrastructure, relies overwhelmingly on municipal bonds. And, remember, the decision of what infrastructure to build and how is made primarily by state and local governments — not investors, not the federal government.
State and local governments usually find the municipal market cheaper and more forgiving than alternative approaches. Muni bond investors often provide 100% debt financing, take entitlement and revenue risk, and invest in new projects.
Institutional investors in public-private partnerships often don't provide these benefits. And they seek returns of 7% to 10% when muni bonds, even those with low credit ratings, cost municipalities half that.
Public-private partnership advocates argue they bring other benefits, including reducing governments' debt burdens, and providing construction and operating efficiencies. But even when governments acknowledge these benefits, they often conclude they don't offset the higher cost of capital.
It's possible the proposed tax credit could change that, but only if governmental issuers can structure transactions so they get some of the financial benefits of the tax credits.
Even if that were the case, our infrastructure problem is not a failure to build the marginal projects that Messrs. Ross and Navarro claim are unable to attract equity investment and on which their plan is focused. What we need is the kind of infrastructure we've financed for decades, when we've been willing to pay for it —schools, roads, bridges, power plants, ports and airports.
Such infrastructure projects are generally of high credit quality. Between 1970 and 2014, only 28 municipal bond issues rated by Moody's Investors Service (other than those of hospitals and housing agencies) defaulted. Very few need equity capital. They can rely entirely on low-cost municipal bonds.
A third reason the proposal might fail institutional investors is that it is based on a tax credit, which is of no value to investors who don't pay taxes —such as pension funds, foundations, endowments and sovereign wealth funds.
Refundable tax credits
In theory, this could be remedied by making the tax credits refundable (which could give the full value to tax-exempt investors) or marketable, so they could be sold to other taxpayers (likely at a pretty steep discount).
But without these features, tax-exempt investors would necessarily have to invest alongside taxable investors rather than pursue direct investing in infrastructure as many are attempting to do. Because most of the return would be the tax credit, such tax-paying partners would likely be able to extract much of the benefit even if they put up little of the money.
In fact, traditional institutional investors might not even be needed. Corporations with ready cash and large tax liabilities could be the primary investors.
As Messrs. Ross and Navarro point out, their plan is synergistic with the new administration's plan to impose a 10% tax on the repatriation of overseas retained earnings. Apple Inc., for example, could repatriate $1 billion (it has $200 billion sitting offshore), pay just $22 million more than its tax obligation and end up owning an infrastructure asset worth $732 million. Why is the money of pension funds, endowments and foundations even needed?
Once again, it's not.
Paul Rosenstiel is a member of the board of the California State Treachers' Retirement System, former deputy treasurer of the state of California and an advisory board member of the Global Projects Center at Stanford University. The views are those of the author and do not reflect the official position of CalSTRS. This content represents the views of the author. It was submitted and edited under P&I guidelines, but is not a product of P&I's editorial team.