With the pending reauthorization of federal surface transportation programs, investing in transportation infrastructure is a hot topic. In particular, how to finance that investment is being strongly contested. The United States faces massive public sector budget deficits, at both the federal and state levels. With spending priorities contending strongly with each other for a share of tax revenues, health, defense, national security, education, and welfare all compete with transportation for public dollars.

No one would argue with the fact that investment in transportation infrastructure is key to economic growth. Funds are needed to maintain the existing road and transit systems as well as to upgrade and expand them. Yet there is a massive shortfall in public funding to do so. The U.S. Department of Transportation’s 2002 report to Congress on “Performance and Conditions” of the nation’s surface transportation system put spending needs for merely maintaining the nation’s transportation infrastructure at roughly $91 billion per year. (The report looked at several average annual investment requirements over the twenty-year period 2001-2020, expressed in 2000 dollars. These were average annual

cost to improve highways and bridges, $106.9 billion; maintain highways and bridges, $75.9 billion; improve transit, $20.6 billion; and maintain transit, $14.8 billion. Given that these numbers were expressed in 2000 dollars over a 20-year period, the actual annual costs are almost certain to be higher).

Reauthorization proposals from the administration, the House, and the Senate for the next six-year reauthorization cycle range from between $250 billion and $375 billion, or at most $62 billion per year. That means that if nothing is done to fill the gap, there will be an annual shortfall between needs and funds of between $30 billion and $50 billion. Each and every year, more than $30 billion that needs to be invested in transportation infra-structure to serve a growing economy will be missing. The traditional source of transportation funding, gas taxes, isn’t keeping pace. Yet there is real opposition to increasing taxes, particularly fuel taxes. So, where can the missing money come from?

There are actually billions of dollars sitting in investment funds—pension funds, insurance funds and others—looking for good investments. Transportation assets, when properly structured, can be great investments. Macquarie Infrastructure Group (MIG) was established in 1996 to invest in road projects. MIG started with four seed assets in Australia and now has 25 assets around the world. The fund has a market capitalization of just over $4 billion, and has interests in assets that are worth approximately $20 billion. It has over 50,000 shareholders, located mostly in Australia but increasingly in other centers where it holds assets. MIG has just started construction of its first project in the U.S., a 12-mile toll road in San Diego called SR125. The facility is expected to be open to the public in the second half of 2006. The project will cost about $800 million in total; MIG is investing $160 million, combined with a $140 million loan from U.S. Department of Transportation through the Transportation Infrastructure Finance and Innovation Act (TIFIA) pro-gram and money from private banks and San Diego Association of Governments, the local MPO. This is the first project of what could be many to follow.

The U.S. economy is many times bigger than Australia’s. With good opportunities to invest, there could be funds many times the size of MIG in the U.S. market to invest in the nation’s transportation infrastructure, providing increased opportunities for maintaining and even improving that infrastructure. The big question is this: Private sector money has invested heavily in transportation infrastructure in many countries around the world—why doesn’t it happen in the United States? There are a variety of reasons for this difference. The U.S. was an early starter in road construction. First parkways and thruways on the East Coast, and then the Eisenhower Interstate system, led the way internationally and established infrastructure that has been the backbone of the economic growth in the U.S for the last 50 years. Other countries started developing road transportation assets much later, in a much more constrained fiscal environment, which required the use of private money for construction and tolls in order to generate a return for the private investors. So, much of the transportation infrastructure in the U.S. was developed when there was no need for private money. But today, that infrastructure is in serious need of maintenance and upgrading that isn’t being adequately covered by public financing.

Because of this history, there are numerous constraints both in legislation and in public policy and culture that make it difficult to make private projects work. Yet one thing is absolutely certain—while there are many transportation projects stalled waiting for funding, there are equally huge volumes of money looking for good investments. Create the environment and the money will flow.

To counter the bias against private investment, and to open the floodgates to private funds, there needs to be a number of changes to federal laws. Based on its experience in investing in transportation infrastructure in the U.S., MIG has developed a range of specific proposals needed to open the market up to private investment. MIG offers these proposals to spur needed debate on private investment in transportation infrastructure, in the hope that they will be useful in reaching a consensus solution.

MIG’s proposals center on changing rules that pose barriers to private investment and changing cultural barriers to private investment. They also include other changes that are important but do not fall into either of those categories. A key barrier relates to private activity bonds (PABs). Currently the threshold for private activity that excludes a PAB from tax-exempt status under the Internal Revenue Code is so low as to make private tax–exempt bonds almost not available. MIG recommends raising this threshold. A higher thresh-old of private activity would allow public authorities to create innovative financing packages by combining available public and private money. In addition, MIG supports expanding the category of exempt facility bonds (that is, bonds that are exempt from the using authority’s volume cap) to include roads (including toll roads, tunnels and bridges) and surface freight transfer facilities. This change would greatly enhance the availability of private funds for investment in transportation infrastructure.

Another significant change needed in the first category relates to sale or lease of federally funded infrastructure assets. Current federal law is not entirely clear whether and under which conditions public authorities may engage in innovative financing by selling or leasing to private investors transportation infrastructure assets that were originally funded using federal money. MIG recommends changing the law to clarify that such transactions are permissible and to specify the conditions under which they maybe entered into.

One of the most significant barriers to private investment in transportation infrastructure is the myriad of extremely costly and time-consuming pre-construction requirements, which can derail a project entirely. Private companies are prepared to put their capital at risk to fund pre-construction activities with the understanding that losses can be recouped over the course of the project. MIG’s experience with theSR-125 toll project, however, proves that they are not willing to do so when the millions of dollars invested can prove a total loss because of problems with environmental and other permitting requirements. On the other hand, if private investors were held harm-less for the cost of pre-construction activities, they could prove to be an important source of funding for such activities, whether the final project itself were to be publicly operated, privately operated, or a public-private partnership.

Therefore, MIG proposes that development phase activities (planning, feasibility analysis, revenue forecasting, environmental review, permitting, preliminary engineering and design work, and other pre-construction activities) be made reimbursable expenses whether or not the project is federally funded. The law should allow reimbursement of the private entity as well as the appropriate governmental authority.

Furthermore, MIG proposes that the federal high-way and transit programs be expanded to allow Federal funding of projects that are privately constructed, owned and operated, with grant funds flow-in through public entities.

Under the MIG proposal, privately owned and operated projects would have to meet all federal requirements, except where federal funding was less than 30 percent of the project cost. Even in the case of such “de minimis” federal funding, some federal requirements would apply. The public interest would be protected in a variety of ways, including a requirement that assets continue in the use for which the Federal funding was provided. In terms of cultural barriers, it is imperative to make changes in the way transportation planners approach the planning process, to ensure that they truly consider private investment. Current law requires lip service, if that, to private investment. And for the most part that is what results. In the UK, by contrast, the mandate to consider private investment has produced a different mind set. MIG recommends a series of changes to federal law to truly integrate private investment in the planning process. These include not only requiring consideration of private investment throughout the planning process, but requiring the inclusion of private operators of major modes of transportation on planning boards. Providing private operators with parity in planning organizations will help to change the mind set against private investment. It will also increase the chance that private investors will become aware of the investment potential of planned projects, thus increasing the flow of investment dollars to transportation projects.

On an unrelated matter, MIG proposes clarifying portions of the law that relate to lifting tolls once construction costs are paid. The Intermodal Surface Transportation and Efficiency Act (ISTEA) made changes to this requirement. However, confusion remains about the requirement, which has inhibited innovative financing transactions on toll facilities. Further clarification is required.

MIG has drafted a bill that incorporates these proposals. The bill also includes other more detailed changes to current surface transportation law consistent with these broader proposals, such as allowing Federal reimbursement of private bond investment in public transportation infrastructure, under the same conditions as for public bonds. Even with the changes proposed by MIG, TIFIA remains a vital resource. There is a real need to make TIFIA money available for planning. Such use is allowed under current law, but for some reason not adequately employed. Also, the administrative process for TIFIA should be streamlined.

With these changes in federal transportation law, culture, and administration, private equity and debt can contribute a greatly needed infusion of capital to provide the requisite funding for not only maintaining, but improving, the U.S. surface transportation system. MIG looks forward to participating in this vital effort to support the national economy.

Nicholas James headed the SR 125 South project finance team for Macquarie Bank's advisory group, and is, based in New York City.