Selling Your Sewer’s Story

Financial statements can make the best case for public works investors.
December 2016
(David Kidd)
By Justin Marlowe  |  Columnist
Endowed Professor of Public Finance and Civic Engagement at the Daniel J. Evans School of Public Policy & Governance at the University of Washington

Every four years the American Society of Civil Engineers (ASCE) deploys a team of experts to grade our national infrastructure. The team analyzes dozens of national data sources to determine the overall condition of our roads, bridges, tunnels and other key infrastructure. Their work is based on a simple concept: When governments invest in infrastructure, the grades improve.

Their most recent Report Card for America’s Infrastructure came out in 2013, and the results were grim. They gave the country’s infrastructure a grade of D+ and said we needed to spend $3.6 trillion just to bring our basic infrastructure back to suitable working condition.

When people talk about an “infrastructure crisis,” they usually quote these figures. The teams will be reporting again in 2017. But there are some problems with the ASCE numbers: It’s kind of a conflict of interest for the people who design public works to tell governments to spend more on roads, bridges and sewers. ASCE acknowledges that its approach is not perfect, but points out that no one else has come forward with a better one.

I have another issue with ASCE. Talking about “American infrastructure” is a bit like talking about “American cuisine.” No two places are the same because local tastes and traditions vary. In fact, many states and localities have ramped up their infrastructure investments in the past few years, mostly because low interest rates have allowed for cheap financing.

That’s why states and local governments need to tell their own stories about their own infrastructure and capital investment needs. And as it turns out, they can tell really compelling stories with their basic financial statements.

About 15 years ago the Governmental Accounting Standards Board (GASB) started requiring states and localities to report the value of their infrastructure assets. Governments can meet this requirement two ways. One is traditional depreciation; the other is a modified approach.

Let me start with the way traditional depreciation works: Consider a system of sewer tunnels built 50 years ago. The city government that owns those tunnels would determine how much it spent to build them, declare how long those tunnels are expected to last and then subtract a portion of the value of those tunnels each year through depreciation. If it builds new tunnels or replaces old tunnels, the rate of depreciation slows. Of course, there are lots of problems with this approach, most notably that many infrastructure assets can last 80 to 100 years. With such a long time frame, annual depreciation is often just a guess.

To solve this problem, GASB created an alternative method known as the “modified approach” or “preservation approach.” Under this strategy, the city would evaluate the condition of those tunnels, and then declare the condition at which it wants to maintain them. Engineers and other experts could weigh in on the declared condition, but ultimately it’s the city’s choice. If the city maintains those tunnels at the determined condition and reports how much it spent on that maintenance, the tunnels need not depreciate. If it fails to maintain them, however, they must be depreciated immediately.

Investors who buy state and local government bonds seem to like the modified approach. In fact, in a recent paper, my colleagues and I found that bonds from governments that use the modified method trade at much narrower price ranges compared to bonds from governments that depreciate. In other words, when a government uses the modified approach, investors are much more likely to agree on how to price its bonds. For governments this can ultimately translate into lower bond interest rates.

Currently, fewer than half the states and just a handful of big-city governments use the modified approach. That’s not a surprise. It’s time-consuming and tedious to implement. And once a government puts it in place, it must constantly reevaluate the condition of all its infrastructure. That’s an expensive proposition.

However, as we hear more and more about the infrastructure crisis, the time might be right for more governments to avail themselves of this powerful storytelling tool.