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The Road Ahead for Funding City Infrastructure Needs

Michael Coleman is fiscal policy advisor to the League. More information on city finance is available on his website at www.californiacityfinance.com.

 

In the coming months, cities will see the first substantial influx of all locations of street and road, housing and other infrastructure funds from the November 2006 bond measures. With this, California’s much needed public works improvements will be under way. In FY 2008-09, it is likely these allocations will continue. Voters have responded to pleas for infrastructure funding, and the state is making good on the commitment to fund local projects. Local governments now have a great responsibility to produce results and, down the road, cities will be asked for greater action and participation in meeting California’s infrastructure needs.

Last November, Californians took a huge step forward to address the tremendous need for statewide public works improvements. Propositions 1B, 1C, 1D, 1E and 84 authorized the state to issue $42.7 billion in general obligation bonds for:

  • Transportation - $19.9 billion (Prop. 1B);
  • Housing - $2.4 billion (Prop. 1C);
  • K-12 and Higher Education - $10.4 billion (Prop. 1D);
  • Flood Control - $4.1 billion (Prop. 1E); and
  • Water, Flood Control and Parks - $5.4 billion (Prop. 84).

Not only are the bonds good for California as a whole, but local governments will also realize substantial benefits. In fact, in the next few years, Californians will see unprecedented and much needed public works improvements in their communities, especially to their streets and roads. In addition to significant funding from Prop. 1B, local street and road programs are scheduled to receive substantial increases in allocations from the state sales tax on gasoline under Prop. 42. New grants for a variety of local transportation, housing, parks and flood control programs will also be available.

If sold over a 10-year period as expected, these bonds will require total debt service payments by the state over the bonds’ life of about twice the $42.7 billion amount -- an annual debt service payment of roughly $2 billion per year for approximately 40 years.

California’s Strategic Growth Plan

As monumental as the November 2006 bond package was, it alone will not bring California within reach of meeting growing public works needs. The governor’s Strategic Growth Plan relies on substantial additional funds from revenue-generating projects, private partnerships and local government resources. The need for public works investment arises not only from the demands of a population expected to grow by 23 percent over the next two decades, but also from existing infrastructure that is aging or inadequate, tighter environmental health safeguards and major new initiatives to counteract climate change. Government services at all levels must accommodate the needs of a population that is continually changing, growing older and becoming more diverse.

Today’s public works improvements must meet much higher standards than ever before. New designs, materials and quality controls help improve public safety and reduce environmental and public health impacts of human activity. These higher standards also make public works improvements much more expensive.

As California’s critical infrastructure needs continue to mount, how much more funding can we expect from the state?

The governor’s Strategic Growth Plan (see Figure 1) anticipates $29.4 billion of additional statewide bond measures in 2008 and 2010 for K-12 and higher education, water supply and court facilities. But the plan anticipates all other additional funding beyond the already approved bond measures to come from revenue bonds ($13.9 billion) and public private partnerships and state-local shared programs ($20.1 billion). Having passed infrastructure improvement bonds of historic magnitude in 2006, the state is now looking to locals to provide new and matching funds for public works improvements.

The Strategic Growth Plan anticipates the approval and issuance of these additional bonds to be timed so that the state general fund’s debt service ratio (cost of annual debt payments as a percentage of general fund) remains under 6 percent. State general fund infrastructure-related debt is projected at 4.4 percent in FY 2007-08, but in order to manage its massive budgetary gaps, the state has turned to various other borrowing mechanisms. This "budget-related" debt includes borrowing from other funds and the debt repayment on the Prop. 57 Economic Revenue Bonds or ERBs (see Figure 2). When the repayment obligations for budget-related debt are added to those of general obligation (GO) debt approved prior to 2006, the state general fund’s debt service ratio exceeds 7 percent over the next three years -- even before any additional debt service from the 2006 infrastructure bonds is added. It is imperative that this budget-related debt is paid off soon for the state to accommodate the implementation of the infrastructure package approved by the voters in November 2006.

Paying Off Existing Debt to Make Room for the New

A tax increase would enable the state to afford greater debt payments, but Prop. 13 imposed a two-thirds supermajority vote requirement on both houses of the Legislature in order to raise state taxes. Faced with this daunting hurdle and a persistent multibillion dollar budget gap, state funding for infrastructure improvements is being squeezed, like virtually all other state programs.

In the absence of a tax increase, the state must pay off the existing ERB obligations as soon as possible in order to accommodate the issuance of infrastructure bonds. Although the governor has proposed accelerating the ERB payoff, the proposals were quickly dismissed by the Legislature in its struggle to find ways to achieve a budget agreement for FY 2007-08. The state’s chronic structural deficit and the state Constitution’s two-thirds vote requirement to approve the annual budget create a situation where solutions that cost a bit now to save a lot later take a back seat to garnering the approval of enough legislators from both parties.

One of the many harmful effects of the state’s continued inability to repair its fiscal holes is how these continuing problems constrain California from taking on more responsibility for infrastructure financing. State bond measures are easier to pass than local bond measures because state measures require a simple majority voter approval. Local bond measures require two-thirds supermajority voter approval, except for most local school bond measures, which require 55 percent approval. If the November 2006 state measures had to achieve these voter approval thresholds, all would have failed -- except the school measure (see Figure 3).

In recent years, well over half of the long-term debt sold by the state has been GO bonds. But local public agencies rely predominantly on other long-term financing techniques, including revenue bonds and various forms of lease financing. Among local governments (and K-14 schools), less than 30 percent of long-term financing was in the form of GO bonds.

What Local Governments Can Do

Local efforts to find resources for essential public works projects face difficult obstacles. Even as needs are greater than ever, so too are the procedural hurdles and limits placed on local governments by anti-tax group-sponsored initiatives.

Tools to build public infrastructure to serve new development are varied. To pay for public infrastructure to serve new development, local governments rely on a combination of Mello-Roos special taxes and assessments charged to property owners, and exactions, dedications and impact fees charged to developers. In addition, state subventions from bond issues and special revenue provide critical funding, and public works enterprises utilize user-fee supported revenue bonds to finance improvements.

It is notably more difficult to fund improvements to existing aging systems and facilities in urban areas. Redevelopment, using property tax increment financing, has been an extremely effective tool to address these needs. But the use of redevelopment is strictly limited to blighted areas. With complex procedures and limitations imposed by the state’s voters, local communities face two-thirds supermajority vote requirements for special taxes, including parcel taxes or any tax dedicated to a specific purpose. GO bonds, which may be supported from existing resources or from an ad valorem property tax increase, also require two-thirds voter approval (see Figure 4). Assessments and property-related fees have their own cumbersome restrictions and are not easily applied to address existing infrastructure deficiencies.

The Need for Legislative Reform

In order for local governments to garner the local resources needed to fund critical local infrastructure needs, they will need additional tools or major adjustments. The Legislature and governor must facilitate their expectations that locals raise matching funds by helping to eliminate state-imposed barriers to local action.

The two-thirds supermajority vote threshold for special taxes is a difficult challenge for any local agency. For some, it is simply unreachable. Many local measures for critically needed services have achieved substantial majority "yes" votes of 55 percent, 60 percent or 65 percent -- only to fail (see Figure 5). The vote threshold for tax increases to fund local government capital projects should be reduced to 55 percent as it is for school bonds. But proposals to reform this undemocratic provision by reducing the requirement of the Constitution have failed to make it out of the Legislature despite the dedicated efforts of some members.

The fact that Californians voted for billions of dollars of bonds to finance infrastructure, transportation and education in 2006 is a fine thing, and those monies will come to local governments soon. The challenge will be to pay off existing debt loads from other financing mechanisms before incurring more. How the state does that remains to be seen.

The Economic Ripple Effect of Public Works Projects

In addition to directly addressing infrastructure needs, cities can expect to experience a positive ripple effect of public works projects in their local economies. Various studies have shown that for every dollar of public infrastructure investment, personal income and employment increases by 10 to 20 percent or more. A billion dollars of public capital improvement project spending will increase direct and indirect employment by about 15,000