President-elect Donald Trump has proposed a trillion dollar plan to rebuild the nation's infrastructure, a plan which the American Society of Civil Engineers has noted would pay for less than one-third the cost of simply repairing our country's existing public infrastructure. He has proposed this be financed in part through tax credits to investors and construction companies — that is, bypassing the nation's state and local governments. Now, a further concern for states and local governments is that the President-elect and Congress may move to tax the interest on municipal bonds issued by states, counties, school districts, and cities to pay for credits or tax cuts in other areas.
It matters, because the federal government has virtually unlimited authority to restrict or expand the inherent taxing authority that the states possessed when they became part of the union—power state leaders have always described as state tax sovereignty essential to their independent existence. It matters too, because, according to the Congressional Budget office, the vast bulk of the nation's public infrastructure investment comes from state and local governments through their capital budgeting processes — a kind of long-term investment in the future which the federal government does not have.
Some of Mr. Trump's economic advisers have questioned whether state and local governments should be able to issue debt on which the interest is exempt from federal taxes: those advisers — such as private-equity investor Wilbur Ross and University of California at Irvine business Professor Peter Navarro — who argue that municipal bonds are an inefficient way to pay for public projects. Their opposition is a reminder of former President Ronald Reagan's tax reform proposals to eliminate the deductibility of state and local taxes and the authority of states, counties, and cities to issue municipal bonds. The duo wrote that private investment and federal tax credits could serve as a "critical" supplement to existing financial programs and replacement for the state and local municipal bonds which have built America.
Indeed, according to the Boston Federal Reserve, annual state and local government spending on capital investment was substantial over the last decade, representing about 2.3% of gross domestic product and about 12% of total state and local spending. In 2012, state and local governments devoted more than $330 billion on capital investment, representing about 14.4% of all state and local long-term municipal debt, excluding private activity bonds. Cities and counties accounted for some two-thirds of that public capital financing.
Perhaps of greater import is that unlike the federal government, states, cities, and counties have both operating and capital budgets and long-term planning processes. The federal government, which has yet to even adopt an operating budget for the current federal fiscal year, has no such capital budget process. Thus, just as the former Reagan plans would have been vastly disruptive to the task of rebuilding America, so too the idea that federal tax subsidies to private investors would somehow be more efficient and effective in addressing the nation's crumbling infrastructure runs the risk of being a bridge too far.
Today, according to census data, state governments are responsible for approximately one-third of state and local capital spending on average. The Boston Federal Reserve notes there is evidence that states with capital budgeting processes invest more on public capital infrastructure than states that do not separate out capital budgets, but which instead, like the federal government, include capital expenditures as part of the regular budget process. Overall, the Boston Fed notes that local governments, over the last decade, devoted $724 per capita on capital investment to states' $374 per capita.
The Boston Fed, noting the critical relationship between public capital investment and long-run economic growth, found the benefits of state and local public capital investment include issues of public safety and our environment — and are critical to addressing the nation's deteriorating public infrastructure, which serves as the foundation for the country's long-run economic growth.
Frank Shafroth is director of the Center for State and Local Leadership at George Mason University.