Spring 2011

An Overview of Highway Finance

Paul A. Fagin
Financing the costs of the federal highway system: historical context,
contemporary problems, innovative funding mechanisms and public-
private partnerships.

PLAN 676- TRANSPORTATION INVESTMENT DECISIONS

 AN OVERVIEW OF HIGHWAY FINANCE

Financing the U.S. highway system is an endeavor that traces its roots back to the early

18th century and the practice of funding roads with local tax revenues. Throughout the 19th and

into the early 20th century the federal government and individual states passed numerous pieces

of legislation that facilitated the growth of the highways. These bills illustrated the national

agenda for transportation investment. As time went on, the methods of financing the highway

system were examined and their merits debated. This conversation continues today and the

growing concern centers on the government’s ability to match the transportation capacity needs

of the country with its current levels of funding. Although no definitive solution has been put

forth, the debate has given birth to several new financing techniques that provide greater

flexibility to the states.

Future funding needs

In his article entitled Future Funding Needs, Francis B. Francois describes the condition

of transportation financing as “falling short of meeting our needs with regard to both our

highways and bridges.” (Francois 1998, 9) This sentiment is shared by a number of stakeholders

within the transportation community and some have even referred to it as an infrastructure crisis.

The traditional method of funding highways has revolved around the motor fuels tax as the

primary revenue source. However, revenue collected from the fuels tax does not account for

inflation and is levied by the gallon. While the emergence of alternative fuels and newer, more

fuel-efficient engines has gradually eroded revenue generated by the fuel tax.

In the face of growing public demand for greater transportation capacity, the government

must decide whether to obligate funds to rehabilitation projects or new construction. To state and

local governments, new construction projects are an attractive choice for spending highway

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funds. But they often divert funds away from much needed maintenance and operation costs of

existing infrastructure and exacerbate the problem on a longer timeline. The convergence of

these issues has led many analysts to spread word of an impending crisis. In fact, this may not be

a crisis, but a condition of the current system of financing and spending.

Some transportation researchers argue that expenditure choices—traditionally favoring

building and managing of infrastructure—must be adjusted to a system of preservation, rather

than new construction. Advocates of this approach claim that a higher priority is accorded to

new highway construction projects, and FHWA figures lend credence to these claims. The

FHWA’s Highway Statistics 1994 publication details, “52 percent of capital outlay spending on

highways by all units of government in that year went for new capacity.” (Dittmar 1998, 12)

New construction will add to the existing infrastructure and momentarily satisfy public demand,

but it will inevitably add to the problem of decaying highways. The evidence would suggest that

transitioning to a program focused on highway rehabilitation and management might also be

more cost-effective than new construction. As Hank Dittmar describes, the “FHWA estimates

that two-thirds of capacity requirements in America’s largest metropolitan areas could be met

with an investment of only $10 billion in ITS improvements, as compared with $150 billion in

highway capacity projects.” (Dittmar 1998, 14) From this self-analysis of the existing

transportation financing condition grew innovative financing approaches.

Innovative Approaches

Over the last ten years, the U.S. Department of Transportation and the Federal Highway

Administration have begun to explore creative approaches of financing new construction

projects. Among the many finance techniques: flexible match, partial conversion of advance

construction, program-level match, reimbursement bond costs, reimbursable loans, tapered

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match, and toll credits. Advocates of innovative financing tools believe the potential benefit to

governments is the ability to leverage existing funds by encouraging private participation and

increase the overall capacity of public sector construction projects. Some critics disagree and

argue that it is merely a “marketing tool used by the federal government to soothe state and local

governments frustrated over constraints on federal funding.” (Grote 1998, 15)

Indeed, the decision to implement new financing techniques was precipitated by

dwindling funds for transportation services and a mounting need for infrastructure improvements

and creation. Moreover, detractors of the existing regulatory scheme—at both the state and local

government level—bemoaned guidelines they felt constrained states’ ability to meet the federal

matching requirement. In many of the innovative financing techniques the ability to induce

private capital into the cash-flow patterns of federal-aid projects was a commonality. Yet many

experts believe financing techniques that seek to entice private investment will ultimately fail,

unless the private sector participation is involved throughout the life cycle of the project.

In Public-Private Partnerships, authors Joseph Giglio and William Ankner write that

early data on private sector endeavors into transportation projects fell short of the desired goals.

From the public sector vantage point there is an underlying belief that the private sector is able to

maximize the efficiency of a project, turn a profit and achieve its goals. But are the goals of the

private sector comparable with those of the public sector? The answer is a qualified “no.” Much

like the public sector, private sector businesses will form around problems that exist within

society and provide creative solutions. However, the end goal for private sector interests is profit

maximization, while the public sector provides services that have intangible benefits, which are,

typically, unquantifiable.

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 The public sector approach has been to use private businesses as contractors, rather than

partners. As Giglio describes, private sector is left out of the initial investment, “nor does it

involve private equity, and thus the private sector has limited incentive to generate the best return

for the project.” (Giglio 1998, 29) Yet the benefits of the private sector—greater operating

efficiency and quality—can be accessed by the public sector if an equity partnership approach is

adopted. An equity partnership allows for public and private interests to share in the risks and

profits of the project over its lifecycle. In order to establish an equity sharing partnership,

however, governments must establish an organizational framework of shared responsibility to

guarantee the success of public-private partnerships.

Concluding Thoughts

Historically, transportation financing in the U.S. was a province of the private sector, but

it was viewed as such a vital service to the country that it eventually transcended into a public

good. As such, the federal government has been the primary supplier of transportation services to

the public. But increasing demands for infrastructure capacity coupled with static revenue

sources have placed the country at a crossroads: federal agencies will need to revise their

expenditure choices or find a way to stretch purchasing power. The evidence would suggest that

a clear path has not been decided on; rather, agencies are exploring both avenues and muddling

through their options. While both choices are viable, there are many organizational arrangements

that must be made before either path can be considered a successful choice.

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Works Cited

Bloom, Madeleine S., et.al. 1998. “U.S. Highway Financing: Historical

Perspective and National Priorities,” TR News, 198: 3-7, 43.

Francois, Francis B. 1998. “Future Funding Needs,” TR News, 198: 8-10.

Dittmar, Hank. 1998. “Is There Really a Funding Crisis?” TR News, 198: 11-14.

Grote, Bryan and David Seltzer. 1998. “Budget Scoring, Highway Projects and
Innovative Finance -- How the Tail Wags the Dog,” TR News, 198: 15-25.

Kreuttzen, Walter and Miriam A. Roskin. 1998. “Direct Federal Credit to Help
Finance Major Transportation Projects,” TR News, 198: 26-27.

Giglio, Joseph M. and William D. Ankner. 1998. “Public-Private Partnerships:

Brave New World,” TR News, 198: 28-33.

Giglio, Joseph M. and Jon Williams. 1998. “Strategic Alternatives For Financing
the Highway System,” TR News, 198: 34-37.