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Funding Innovations for California's Infrastructure (full report)

Promises and Pitfalls

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Document date: April 13, 2006
Released online: April 13, 2006

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Note: This report is available in its entirety in the Portable Document Format (PDF).

The text below is a portion of the complete document.


1. Introduction

In his January 2006 State of the State address, California’s Governor Schwarzenegger unveiled an ambitious ten-year plan to rebuild the state’s infrastructure (Schwarzenegger, 2006). In doing so, he evoked the legacy of his predecessors from the 1950s and 1960s, who oversaw a major public investment program in roads, schools, and water supply to accommodate the post-war population boom.

The infrastructure challenges facing California today rival those of that earlier period, often considered a “golden era” of public investment. Although the population growth rate has slowed, the absolute increases are still substantial – on the order of this century (Johnson, 2005). Meanwhile, it has become more difficult to build, as Californians have become more ambivalent about the consequences of growth on the environment and the quality of life (Barbour and Lewis, 2005). They have also become more reluctant to tax themselves for public works. In the years since the 1978 passage of Proposition 13, California’s legendary property tax revolt, the state’s voters have passed additional restrictions on local taxing and fee-raising authority, making California arguably one of the most difficult places in the nation for increasing local public revenues.

The public’s reluctance to raise taxes is a consistent message emerging from opinion polls,4 and it is a message that the state’s elected officials have chosen to heed. State infrastructure investments in the late 1990s and early 2000s were largely funded by floating general obligation (GO) bonds (de Alth and Rueben, 2005). Governor Schwarzenegger came into office in late 2003 on a “no new taxes” platform, and his infrastructure plan maintains that promise (Office of the Governor, 2006). The plan relies instead on various forms of debt financing, earmarking of existing revenues, and increased federal contributions. It does call for new user fees, some of which would back new private equity investments in transportation. It also aims to save costs through reforms in transportation project management and contracting.

Many of these proposals are drawn from the toolkit of “innovative financing” that has been gaining popularity with governments nationwide as they aim to stretch the infrastructure dollar. Particularly in the transportation sector, there has been growing interest in the potential for public-private partnerships, new types of user fees, and new debt-financing instruments to enable faster completion of projects, increase costeffectiveness, and mobilize new capital resources.5 Such innovations often require changes in legislation and in the way public agencies oversee or operate projects. The successful introduction of new user fees, which can help manage demand growth while generating revenues, can also require changes in public perceptions.

In this paper, we examine the potential for funding innovations to enhance California’s ability to meet its civil infrastructure needs. We compare elements of the “innovative finance” toolkit with some of the more traditional taxing instruments available to state and local governments, and we examine the trade-offs between bond and pay-as-you-go financing. This broad perspective is important, because ultimately, all civil infrastructure must be paid for by user fees or taxes. Although various debtfinancing tools make it possible to augment today’s investment resources, they place a claim on future revenue streams, thereby reducing funds available for future investments as well as future current expenditures.

The analysis focuses on two sectors that have been singled out as particularly suited to innovation – transportation and water. In both cases, user fees have historically been an important source of revenue, in contrast to sectors funded primarily by general taxes, such as public education. Both sectors also present opportunities for increased private sector participation in operations, management, and investment. And both face funding challenges. For transportation, a central issue has been the erosion of the primary user-fee based revenue source – per gallon fuel taxes – through inflation and improved fuel efficiency. For water, the core challenge is to develop appropriate mechanisms to fund programs outside of the traditional purview of utilities, such as flood control and environmental mitigation.

The paper is organized as follows. Section two provides some background on infrastructure financing in California, including spending patterns and sources and the nature of existing funding constraints, both overall and for the two sectors of interest. Sections three and four assess the experience to date with funding innovations in transportation and water, respectively, and highlight the opportunities and potential drawbacks of new approaches. A concluding section summarizes the main findings.

4 Surveys show the public equally divided between increasing taxes to provide more government services and decreasing spending. This impasse has contributed to the state’s fiscal troubles and structural deficit in the aftermath of the bursting of the stock-market bubble. The only taxes for which there is broad public support are “vice” taxes (cigarettes and alcohol) and taxes for the wealthy. See Baldassare, 2004a, 2004b, 2005, and 2006.

5See, for instance, Congressional Budget Office, 1998; U.S. Department of Transportation, 2004; General Accounting Office, 2004.

Note: This report is available in its entirety in the Portable Document Format (PDF).



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