Consider what our nation's transportation system would be like if we were still using only technology and ideas developed in the 1950s!

In this imaginary "time warp," great improvements in transportation design, construction processes, improved building materials, planning procedures, safety, and environmental improvements would not be available to the traveling public. Fortunately, this is not the case, and our nation's transportation infrastructure is second to none in its capacity to move goods and people safely while enhancing the environment.

While the way we plan, build, and provide for our nation's transportation services has been improved and modernized continuously, the way we pay for transportation infrastructure has been slower to change. To a large degree, we are still using a single strategy that has not changed since the 1950s to finance transportation infrastructure improvements.

The National Highway System (NHS) Designation Act of 1995 has changed all that with major improvements in the way states may finance NHS and other transportation infrastructure. This historic legislation, signed by President Clinton in November 1995, advances important provisions that enable the states to increase and speed up investment of federal funds in transportation projects - both on and off NHS.

Need for Improvements in Financing

America has always been a nation in motion. We have moved further, gone faster, and made more progress in our short history than any other nation on earth. As the United States approaches the new century, the condition of our transportation infrastructure will be even more crucial to economic growth, international competitiveness, and overall quality of life.

The legislative approval of NHS was a major accomplishment. In the NHS Act, Congress recognized that we must also make improvements in financing so that needed projects can advance, even in a constrained budget environment.

Despite record levels of transportation investment by all units of government and private industry, a significant funding shortfall threatens the vitality of our transportation system and affects the ability of our workers and our companies to compete and prosper in global markets in the 21st century.

A recently submitted report to Congress from the Department of Transportation (DOT), Status of the Nation's Highways, Bridges, and Transit: Conditions and Performance, explains that in 1994, $49.9 billion was required to maintain the overall condition and performance of the nation's highways and bridges. Improving highways and bridges would have required an investment of $68.2 billion in 1994. The actual 1993 investment of $34.8 billion was 70 percent of the amount required to maintain the highways and bridges and only 50 percent of what was needed for improvement.

A Policy Gap in Transportation Financing

Along with the "investment gap" between financial resources and transportation needs, a "policy gap" between modern financing options and current financing practices has also emerged. Based on the traditional model of gas tax revenues, current highway financing practices remain largely based on the single strategy of grant reimbursement. This strategy is limited in range, slow to change, and not sufficiently productive to meet investment requirements.

In recognition of this policy gap, Congress - in the National Highway System Designation Act of 1995 - enacted a number of improvements in the way the states and others may finance NHS and other transportation infrastructure. Collectively, these provisions are termed "Innovative Finance" because almost all had their beginnings in the Federal Highway Administrationfs (FHWA) Test and Evaluation Program - Innovative Finance (TE-045).

Giving States New Financing Tools and Flexibility

To address the deficit between growing financing requirements and decreasing financial resources to meet these requirements, FHWA has sought to increase the financial flexibility available to the states. FHWA's own NHS legislative proposal, S.775, which was transmitted to Congress in May 1995, contained important financing options that build on the flexibility made available under the Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA). These included more flexible state matching requirements and voluntary state transportation infrastructure banks. States would also have increased flexibility to use federal highway funds for advance construction projects, bond interest and issuance costs, and loans to ISTEA-eligible projects.

Leveraging Greater Private Sector Participation

These initiatives grew out of DOT's efforts to seek greater private sector participation in response to President Clintonfs executive order "Principles for Federal Infrastructure Investment." The legislative initiative was also based on a very favorable response from the states to the FHWA's Innovative Finance Test and Evaluation Program (TE-045), which seeks to increase and modernize investment in transportation infrastructure.

Making TE-045 Work

Using special authority in Section 307 of Title 23, FHWA began its innovative finance effort in spring 1994. FHWA took a proactive, practical approach. FHWA asked the states to make full use of the financial flexibility in ISTEA and bring forth critically needed projects and creative proposals on how to finance them.

Innovative Finance Case Study Ohio: Butler County Highway

The Ohio Department of Transportation will construct a four-lane, 16.5-kilometer road, and extra lanes on the interstate highway to accommodate a proposed interchange. The project, the Butler County Regional Highway, is based on state legislation that established a transportation improvement district in the area. The project costs $132 million. Because of the good prospect of future federal funds, the state can borrow more easily to finance the project. As a result of advance construction eligibility and flexibility, the state can obtain better financing for an intergovernmental loan and/or private bonds for the project.

Innovative Finance Case Study South Carolina:
Conway Bypass

The South Carolina Department of Transportation plans to build a link between U.S. 17 and other major roads that lead to the Grand Strand/Myrtle Beach area, increasing access to the state's largest tourist area. The link is a limited-access, four-lane and six-lane highway covering almost 46 kilometers. The project, which will cost $412 million, tests a number of innovative finance concepts. The state is applying the ISTEA Section 1012 loan approach to a non-toll facility with a dedicated revenue repayment source. This loan for the estimated construction cost of the project provides cash to service the bonds supporting the project. Bond principal and interest on the project will be repaid using innovative finance flexibility. By combining innovative financing and innovative contracting, this project is expected to save more than $100 million, and construction is being accelerated by 20 years. Local sales tax revenues will also fund a portion of the project.

From its beginning, the Innovative Finance Program had these goals:

• Create incentives for states to take full advantage of ISTEA financing opportunities.

• Learn which new financing strategies and policies really work and make the changes that are needed.

• Assist states in their efforts to leverage their current funding and produce additional funds - both public and private.

• Move projects into construction more quickly than under traditional financing procedures.

34 States Using Innovative Finance to Move Projects

To date, 67 projects in 34 states with a total value of more than $4 billion have been accepted in the Innovative Finance Program. In addition, these projects reflect increases in public or private investment above conventional financing at the usual federal-state cost-sharing ratio.

The innovative finance techniques that are designed to make more funds available to states and other transportation providers are termed "leveraging tools." And because of the increased flexibility that states now have, most projects will advance to construction years ahead of schedule - some by as much as 20 years! The innovative finance techniques that have to do with when federal funds become available to states are termed "cash-flow tools."

Making Financial Improvements Administratively

While most innovative finance tools required legislation so that all the states could use them on a permanent basis, FHWA was able to make two very important changes on its own - using administrative authority. These changes were made some months before the NHS legislation was enacted.

ISTEA Section 1044 allows states to earn credit from toll revenue expenditures. The state can apply the credit towards the non-federal matching share of all programs authorized by Title 23 and ISTEA. To the extent credits are available, a state may use up to 100 percent federal funds on benefiting projects. To earn credits from toll road expenditures, a state must meet a maintenance of effort (MOE) test.

As a result of an April 1995 FHWA policy change made as a direct result of TE-045, a state can now pass the MOE requirement by demonstrating that it is keeping up its commitment to non-federal transportation investing prospectively or retrospectively. Up to this time, only the single retrospective test had been available. The new test gives more states the opportunity to earn these credits and to free up state funds - that would otherwise have been required to meet matching requirements - for use on other projects.

As a direct result of TE-045, FHWA regulations were changed in July 1995 to allow an advance construction project to be converted to a regular federal-aid project in increments over a series of years. The ability to partially convert advance construction allows positive cash flow to be realized as needed throughout the life of the project. Under traditional funding, a state would have been required to wait until it had funds and obligational authority available for the full federal share before converting an advance construction project.

The NHS Act's Innovative Finance Tools

The favorable response by the states, local governments, and private sector to FHWA's initial financing concepts prompted Congress to include a number of these techniques in the National Highway System Designation Act of 1995. By attracting new sources of capital to transportation infrastructure and by enabling projects to move ahead more quickly, the new financing techniques provided in this legislation will support vital NHS and other transportation projects. The innovative finance provisions, as well as an innovative finance case study that tested the tool, follow:

Increased State Advance Construction Flexibility (Section 308)

DOT can now approve an application for advance construction for reimbursement after the final year of an authorization period provided the project is on the state's transportation improvement program (STIP). STIP is fiscally constrained under Section 135(f) of Title 23. This change also provides greater flexibility to states to engage in advance construction using their anticipated apportionments. This important change significantly increases state flexibility to go forward with advance construction projects.

Innovative Finance Case Study Ohio: Stark County Intermodal Facility

The Ohio Department of Transportation has constructed an intermodal facility that enables the loading and unloading of truck trailers and freight containers onto railroad flat cars. The overall development cost was $35.2 million. The truck off-loading fees function as a dedicated revenue stream in order to qualify the project for a loan under that innovative finance concept. The loan will be paid back by a special fee on trucks using the facility. The loan will also enable the state to establish a revolving fund. The project leverages $24 million in private funds and saves or creates about 1,000 manufacturing jobs in the state.

Expanded Access to Capital Markets (Section 311)

States can be reimbursed with federal-aid funds for bond principal, interest costs, issuance costs, and insurance on Title 23 projects. Before this change, federal-aid funds were limited to bond retirement costs on certain categories of projects and interest costs were only eligible on some interstate highway projects. Now, private-sector capital can be more cost-effectively attracted to transportation projects when bonds, notes, and other debt instruments are supported by both state and federal-aid funds.

Increased Federal Share for Many Toll Projects (Section 313a)

This provision sets the federal share for toll projects on highways, tunnels, and bridges at a maximum of 80 percent of eligible costs. Up until now, the federal share for toll projects has varied from 50 percent to 80 percent, based on activity and system designation.

Expanding Project Loans to Non-Toll Projects (Section 313b)

States can now loan federal-aid funds to toll and non-toll projects with dedicated revenue streams. This provision will also permit interest rates at or below market rates, as needed, to make the project feasible. This section also expands the use of re-paid funds that can now be used for credit enhancement on similar projects. Up until now, loans could be made to toll projects only at the states' pooled-fund investment rate, and re-paid funds had been limited to project purposes.

Innovative Finance Case Study Maine: Fairfield Intermodal Facility

The Maine Department of Transportation will construct an intermodal truck-to-rail transfer facility near Fairfield. Located less than two kilometers from the interstate highway, the facility will provide for the transfer of truck freight from major U.S. highways to key rail lines, both in Maine and throughout New England. Under the innovative financing effort, a private rail company is contributing material, equipment, and services for use in the project. The state is crediting the value of the rail contributions toward the state's share of project costs. The rail contribution saves the state $1.57 million, which can be used elsewhere for transportation.

More Flexible State Matching Requirements (Section 321)

This important provision allows private funds, materials, or assets to be donated to a specific federal-aid project and permits the state to apply the value to the state's matching share. To date, states could only receive credit for state and local funds or for donations of private property incorporated into a federal project.

State Infrastructure Bank (SIB) Pilot Program (Section 350)

Up to 10 states may test the use of SIBs as a means of increasing and improving both public and private investment in transportation. DOT has already established procedures to solicit candidates for the pilot program and determine which states will make the best pilots. Pilot SIBs will be able to provide loans, enhance credit, serve as capital reserves, subsidize interest rates, ensure letters of credit, finance purchase and lease agreements for transit projects, provide bond or other debt financing security, and provide other assistance that leverages funds. Federal oversight is maintained by an annual reporting requirement and by requiring an investment-grade rating on debt issuances or the maintenance of bond insurance to assure the viability of the fund.

Based on the outcome of the SIB Pilot Program, SIBs may factor prominently in the future of transportation financing. Because SIBs offer varied leveraging tools, such as loans and credit enhancement, they hold promise to many states, multistate entities, and other providers. Some estimates are that SIBs may leverage federal funds by a ratio of 4-to-1.

Looking to the Future

Consider what our lives would be like if American family finances operated on a single "pay as you go" grant reimbursement strategy - as to a large degree, we used to pay for transportation improvements. Few Americans would be able to afford higher education for their children; fewer still would be able to live in their own homes! Automobiles and major home appliances would be out of reach for many Americans.

The NHS Act significantly modernizes transportation financing. The legislation makes transportation financing more flexible and more adaptable to the many challenges that exist in the states. In some ways, transportation financing can now work more like the way a good family budget works!

Comparing Interstate and NHS Financing

Just as the 1956 interstate highway legislation authorized the Interstate System and shaped the federal highway program for nearly 40 years, the NHS legislation will shape the federal highway program and financing well into the 21st century.

While the 1956 legislation was accompanied by the creation of the Federal Highway Trust Fund and a federal motor-fuel tax, no new special federal revenues are available for NHS. However, the innovative finance provisions in the NHS legislation help leverage additional dollars for NHS and other projects by making better use of modern financing techniques.

Innovative Finance Case Study California: San Joaquin Hills and Foothills/Eastern Corridor Projects

Together the corridors issued nearly $3 billion in revenue bonds for new toll facilities in Orange County. The San Joaquin Hills and Foothills/Eastern Corridor Projects received a federal line of credit through provisions in the 1994 and 1995 federal appropriations bills to cover perceived risk if actual traffic levels fall short of projected levels. If traffic levels do not meet projections and revenue shortfalls occur, the agency can borrow a predetermined amount of funds from the federal government to pay debt service on the bonds.

Infrastructure banks and credit enhancement could be even more powerful tools when combined with the design/build techniques of innovative contracting.

FHWA is exploring ways that the federal credit concepts used to support these toll projects might be made available on a programmatic basis and might be available to provide credit enhancement to infrastructure banks.

Emerging New Paradigms and ISTEA Reauthorization

A new paradigm for NHS highway financing is likely to emerge in the near future. While grant reimbursement will continue as a major federal-aid financing tool, it will be increasingly supplemented by innovative ways to meet transportation finance needs. States can be expected to make widespread use of the innovative finance concepts in the NHS legislation, as well as those made available administratively by FHWA.

Bold, new, next-generation financing ideas are likely to come on line as FHWA, the states, and other transportation providers continue to seek to meet public demand for transportation projects. For example, FHWA is testing the use of direct federal credit enhancement concepts with two toll road projects in California.

These innovative finance tools pioneered by FHWA and the states over the past two years are not the end of the road. As we look ahead to ISTEA reauthorization, we will seek ways to push into new territory, to leverage new funds, expedite project delivery, and provide state and local governments with new flexibility.

Jane F. Garvey is the deputy FHWA administrator. From 1991 to spring 1993, she was the director of aviation at Logan International Airport in Boston, directing airport management and capital planning. In 1988, after serving five years as the associate commissioner, she became the commissioner of the Massachusetts Department of Public Works, the agency responsible for construction and maintenance of the state's highways, bridges, and roadside areas.