To: President-elect Obama, Speaker Pelosi and Majority Leader Reid
Re: Your stimulus plan: Avoid waste with a meaningful local match
As you finalize the language for the stimulus package, here's a simple tip from seasoned financial professionals in the state and local government sector, where you plan to target a large part of the most important national fiscal stimulus plan in 75 years: Don't give money away without requiring a hefty matching state or local government contribution.
Every governor, mayor, county commissioner and school board president now has visions of "Candyland" in mind as they drool over the prospects of "free money" from the federal treasury to pay for capital projects they would never in their right mind dare to finance with local taxpayer dollars. You will need to answer the fiscal conservatives in the Senate who challenge the wisdom of hasty public works undertakings that build bridges to nowhere and other frivolous capital projects. Fortunately, there is one sure-fire way to assure that federal dollars are not wasted in the rush to get the economy moving again. All it takes is a significant local matching contribution.
There is a time-tested principle in public finance: When the price is zero, the demand is infinite. This applies particularly to federal aid to states and localities. The wish list of capital projects already submitted by the politicians is already big enough to stimulate the U.S. economy -- and the news media -- for an entire decade. One news report of the 11,000 projects on the mayors' recent Christmas list revealed schemes for a polar bear park in Rhode Island, a program for reducing prostitution in Dayton Ohio, corporate jet hangars in Arkansas, a minor-league baseball museum in North Carolina, a water park and aquatic centers. Those are clear examples of what nonsense is coming your way if you simply hand out "free money" in your rush to jolt the economy back to life. Your problem now is how to ration finite stimulus dollars to achieve maximum impact, create more jobs for each federal dollar spent, and assure that nobody wastes the U.S. taxpayers' money.
For example, purely local projects should receive no more than 33-50 percent federal funding, under any circumstances. That would include local roads and bridges, school building renovations, water and sewer facilities, and similar projects that have no interstate users of significance. For interstate projects, such as the highways and bridges that link the nation, the federal share can be a higher percentage to reflect the benefits that taxpayers from other states derive. Although the interstate highway system originally was built with 90 percent federal funding, the replacement of those facilities should probably be financed with local shares of at least 25 percent when the local usage is greater than that. A formula can easily be crafted to calibrate the federal share based on usage statistics that are generally available from traffic studies and similar user surveys.
The problem with federal funding is that nobody is held accountable for wasteful projects. The local members of Congress get full credit for bringing federal money to their constituents, which is almost the exact opposite of fiscal accountability. Only when state or local officials must put their voters' money on the line will there be any chance to achieve accountability and fiscal sanity in this process.
If you want to increase the federal aid for any given project, there is another way to accomplish that, as I have explained in my previous column on infrastructure spending. By providing financial incentives to state and local governments who borrow their share in the financial markets, the local taxpayers and media will be your watchdogs. Projects that lack economic merit will fail the local financing test and won't be submitted for federal funding. It's a wonderful check-and-balance system that works especially well in the federalist system.
And without spending a load of federal money, you can achieve leverage of 2-1 to 50-1 on the federal taxpayer's dollar if you also consider these simple proposals to re-open the municipal bond market for qualified public works projects:
1. Bank-qualified bonds. Smaller projects to build infrastructure can be financed at the local level without direct federal support if Congress simply raises the limit for one year on the volume of bank-qualified tax-exempt debt that local governments issue for public facilities. This move alone will provide an answer to local demands for funding projects that have primarily local benefits.
2. Up-front federal aid. By providing the federal match up front on fast-track projects, the federal government can accelerate the speed with which important public works projects are undertaken. That will give state and local governments time to prepare their bond issues and raise the funds they need for their share, even as ground is being broken on the construction.
3. Federal re-insurance of state infrastructure bonds. The municipal bond insurance market has frozen up, pushing issuers' costs higher. Congress can significantly reduce the borrowing cost of state governments that build infrastructure this year by co-signing the loan guarantees. It would be a low-risk and low-cost way to get the states moving again.
4. AMT tax relief for revenue-producing public facilities bonds. To fast-track construction of airports and hospitals, Congress should waive for one year the Alternative Minimum Tax on these quasi-public facilities. I personally would not extend this incentive to professional sports facilities, although some people might consider that a way to stimulate construction, so perhaps a revenue rule that requires the interest savings to go to the public and not the billionaire team owners?
5. Taxable municipal bond option. For public projects funded with federal funding exceeding 60 percent of the total expense, it would not be unreasonable to require the states and localities to issue taxable bonds for their share. This would raise their interest costs by about 20 percent on their share (making it less than 8 percent of total costs) in exchange for getting 60 percent federal funding, which is a good trade for them any day, but also ensures that there is local skin in the game.
Instead of giving away tax revenues to wealthy investors, this approach would increase future federal tax receipts while still enabling public agencies to get their projects off the ground. For example, the voters in metropolitan Los Angeles recently approved a sales tax increase for transportation projects, and officials there would have ample resources to accelerate and expand their plans with federal assistance. So if they do receive federal aid, they can easily afford to have their bonds carry a higher interest rate as a condition of receiving major federal matching funds which were not anticipated by the voters. The IRS will collect 35 percent more tax revenue, which makes this arrangement far more cost-effective than allowing such federally assisted infrastructure bonds to be sold tax-exempt. The same would apply to California's recently approved high-speed rail project, which is already funded but which will undoubtedly seek federal aid under the stimulus program. Without provisions like these, you will simply shift the expense of already-approved projects from local taxpayers to the nation at large.
If you simply write checks for the entire tab to the states and localities, there is no doubt that some of the projects you fund will be wasteful, unnecessary or simply substitute federal dollars for local dollars already committed to the same purposes. Without a significant local matching requirement, governors and mayors will treat federal infrastructure aid the same way as taxpayers treated last summer's rebate checks -- they will shuffle the money around to strengthen their own balance sheets, defeating the purpose of your stimulus spending. Please don't be pound foolish, when a simple matching requirement would protect federal taxpayers and produce better results for everybody. The economics are compelling, and only the greediest and seediest politicians will complain.
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