Breakingviews: Beware cracks in Trump’s infrastructure plan

Published Wed, Jan 11 20174:22 PM EST

Breakingviews

Richard Beales

The need for hefty investment in America's infrastructure was one of the few unifying themes of the country's raucous election. Just ahead of the vote last November, two of President-elect Donald Trump 's lieutenants drafted a superficially appealing outline to attract a whopping $1 trillion in private-sector funding. The tax credits involved are a potential giveaway to businesses and investors. Other assumptions are fanciful, too. The plan's co-authors, Wilbur Ross and Peter Navarro, have since been selected respectively as Trump's commerce secretary and the head of a new White House trade advisory group. The U.S. Senate has delayed Ross's confirmation hearing until next Wednesday because Ross hasn't completed the necessary paperwork. Lawmakers shouldn't let partisan concerns distract them from probing how he aims to promote investment in highways, railroads, airports, fiber networks and other infrastructure. More from Breakingviews : Trump business-conflicts failure lines up gridlock The basic idea from Ross, a billionaire buyer of distressed businesses, and Navarro, an economics professor at the University of California, Irvine, is to give investors who put up the riskiest type of capital for infrastructure a big tax credit. That is designed to encourage them to part with their cash and make it go further in attracting additional private-sector debt funding. Relatively easy-to-fund projects, or shovel-ready ones, that have attracted investors to President Barack Obama 's so-called Build America Bonds are less the target now. Nearly $200 billion of these bonds were issued under a subsidy program endorsed by Ross and Navarro, helping to finance everything from school construction to larger transport-related initiatives. Such projects can have pre-agreed or highly stable revenue streams, making near-100 percent debt financing feasible. Others are less predictable, though. Income from most toll roads, for example, depends on how many people use them and what the operating costs turn out to be. Here's how it might work, using Ross and Navarro's financial outline. Consider the residents of Elite Avenue, a private road in need of pothole repairs and resurfacing work costing $1 million. Mrs. Rich, owner of the biggest house on the street, puts up $167,000 in so-called equity, and the rest is borrowed. In exchange, she gets a tax credit for 82 percent of the investment, so is really only on the hook for $30,000. Everyone on Elite Avenue pays each time they use the new road, and the tolls cover the interest and principal on the loan. Whatever is left over is profit for Mrs. Rich, but charges to use the road can be less than they would have been without the tax credit because she only needs to be compensated for a fraction of her initial investment. Once the debt is paid off and the wealthy neighbor has made a return, maybe the road becomes the communal property of all Elite Avenue dwellers, or maybe Mrs. Rich gets to own it and keep charging: that's not specified in the draft from Navarro and Ross. The twist that makes the proposal look revenue-neutral, to use the Washington jargon, is that the tax credit – nearly $140,000, in the Elite Avenue example – is earned back by the government because the contractor who fixes the road employs people who pay tax, and because he also makes a 10 percent taxable profit on the work. It's true that for lenders to get interested in projects with uncertain revenue prospects like Elite Avenue, they need to see investors provide an equity cushion. That explains the idea of directing incentives that way. Banks and bond investors aren't stupid, though. If they see an investment by a wealthy resident, a big company or a billionaire like, say, Ross almost entirely canceled out by a tax credit, they aren't going to take the cushion seriously because the investor no longer has enough skin in the game. To benefit, the provider of the equity capital also needs to be a big taxpayer in the first place. That means large corporations and managers of substantial funds, not small businesses or everyday investors. Then there are the underlying assumptions made by Ross and Navarro. One is that, even before the tax handout slashes the equity component, the debt-to-equity ratio of the typical targeted project would be five-to-one. This is what enables them to suggest that attracting $167 billion of equity could activate $1 trillion altogether in private funding for infrastructure. Five times as much debt as equity probably wouldn't fly, however, even if lenders could be persuaded to ignore the tax credit. For anything with a risky revenue stream, three-to-one might be nearer the mark. This in turn throws off the rest of the analysis. The total cost of covering both equity and debt returns over the life of a project, which they calculate could be up to 20 percent lower with the tax credit than without, would not fall by as much with less debt and more equity. Subsidized debt, such as Build America Bonds, would become more worthy of consideration, rather than subsidized equity. And their argument that the tax consequences are neutral would crumble, too. Revenue neutrality requires the assumption that a given infrastructure investment would not happen in any form without the tax credit, and associated jobs wouldn't exist at all. That's already a stretch. Then it assumes that a combination of income tax on construction employees and corporate tax on the project builder will add up to cover the credit, an equation which conveniently balances almost perfectly in the analysis presented by Ross and Navarro. With reduced leverage – in other words, a higher proportion of equity – the tax handout becomes larger and the supposed new tax receipts fall short. The authors trumpet the idea that no new government bureaucracy would be needed to make infrastructure loans under their plan. That may be right, and it also could be fair to say that Clinton 's infrastructure bank idea would have been complicated and hampered by red tape. However, the plan from Ross and Navarro would need more supervision than they allow. For one thing, big tax credits offered without meaningful monitoring risk either becoming windfalls for their recipients or mechanisms for officials to dish out financial advantages. That's simply another embodiment of the "crony capitalism" Trump's men criticize as a risk in the plan offered up by Hillary Clinton. Consider a possible scenario with the Elite Avenue project. Suppose Mrs. Rich teamed up with the contractor and held a 50 percent financial interest in the company fixing the road. This wouldn't be unusual in the world of infrastructure. Then she would collect half the expected 10 percent (or $100,000) construction profit. After applying the 15 percent corporate income tax assumed by Ross and Navarro, the sum would amount to over $40,000. Mrs. Rich is only on the hook for $30,000 in equity, net of the tax credit. That means she'd be ahead on the deal before the road's surface even needed to survive its first winter. Second, without a careful prior assessment, there might never be new tax receipts for the government, only the handout. That would make it no different from a direct subsidy, risking the kind of outcome the authors call "scandalous" in the context of Obama's Energy Department losses on $535 million of loan guarantees offered to bankrupt solar-panel maker Solyndra (Incidentally, the loan and guarantee program concerned is showing a modest profit overall because other beneficiaries have paid enough interest on loans to cover losses to date). Any suggestion of handouts would, in turn, raise the question of whether direct government borrowing might be a more efficient way to pay for some infrastructure, with 30-year funds costing around 3 percent, against Ross and Navarro's assumptions of 5 percent interest on debt and 10 percent returns for equity. This isn't to say there's no role for tax credits. After all, they're just subsidies by another name, and incentives are often needed to turn policy into reality. Broadly speaking, fresh ideas are welcome, too, along with numbers that can be examined, something Ross and Navarro helpfully provide. They also rightly link the accessibility of funding to streamlined approval processes for infrastructure projects. Spurring $1 trillion of private investment without indulging in corporate welfare, however, demands a more hands-on role for government than Trump's team is willing to admit. For more independent commentary and analysis from Reuters Breakingviews, visit breakingviews.com .

A worker operates a Caterpillar Inc. 336D hydraulic excavator during construction on Route 7 near Falls Church, Virginia.

Hassan Sarbakhshian | Bloomberg | Getty Images

The plan's co-authors, Wilbur Ross and Peter Navarro, have since been selected respectively as Trump's commerce secretary and the head of a new White House trade advisory group. The U.S. Senate has delayed Ross's confirmation hearing until next Wednesday because Ross hasn't completed the necessary paperwork. Lawmakers shouldn't let partisan concerns distract them from probing how he aims to promote investment in highways, railroads, airports, fiber networks and other infrastructure.