Spending on Infrastructure and Investment

Posted by Chad Shirley on
March 1, 2017

The federal government spends hundreds of billions of dollars every year on infrastructure and other investments, either directly or through grants to state and local governments. During testimony that CBO’s Director gave at the beginning of February on the outlook for the federal budget and the economy, some Members of Congress asked about issues related to infrastructure and investment. Because answers during Congressional hearings need to be brief, this blog post provides additional information about those issues and highlights some of CBO’s related work.

What Kinds of Infrastructure Do Federal, State, and Local Governments Invest In?

Almost all spending on transportation, drinking water, and wastewater infrastructure is done by the public sector. Federal, state, and local governments spent $416 billion on it in 2014. That amount equaled about 2.4 percent of gross domestic product, a percentage that has been fairly stable for roughly 30 years. The largest amount of public infrastructure spending in 2014 went to highways ($165 billion), followed by water utilities and mass transit and rail.

About a quarter of the $416 billion (roughly $100 billion) came from the federal government, and three-quarters (a little over $300 billion) came from state and local governments. Of the federal spending, roughly two-thirds paid for new, improved, or rehabilitated structures and equipment. State and local governments spent money on those things as well, but a much larger proportion of their spending paid for the operation and maintenance of infrastructure.

Furthermore, state and local governments pay for most of the facilities that schools require.

What Else Does the Federal Government Invest In?

The federal government pays for a wide range of goods and services that are expected to be useful some years in the future. Those purchases, called investment, fall into three categories: physical capital (which includes infrastructure), research and development (R&D), and education and training. In 2015, the federal government spent $293 billion on nondefense investment. The federal government also spent $180 billion on defense investment, chiefly in physical capital and R&D. All told, investment has recently represented about 15 percent of federal spending.

How Would Increasing Federal Investment Affect the Economy?

CBO has found that federal investment affects the economy mainly by changing overall demand in the short term and gradually boosting private-sector productivity in the longer term. Some investments in infrastructure start improving productivity soon after they are made, whereas other investments, like many in R&D, take much longer. Also, some investments have stronger effects on productivity than others do.

The overall effect on the economy of increased federal spending also depends on how much state and local governments adjust their own investment in response. It depends, too, on whether the federal spending is financed by reducing spending for other programs or by borrowing additional funds.

How Could the Federal Government Encourage More Efficient Use and Financing of Infrastructure?

Almost all federal spending for highways occurs through formula grants to state and local governments, and less than half of the funding has been tied directly to the amount of travel on the roads. Lawmakers could consider ways to increase the productivity of highway spending: charging drivers for their highway use, allocating funding on the basis of benefits and costs, or linking funding more closely to performance measures.

One way to finance infrastructure spending more efficiently would be to change the nature of the tax preferences that the federal government offers to buyers of municipal bonds, which are often issued to finance highway construction projects. Tax-exempt bonds are a relatively inefficient way to subsidize state and local governments’ investment in infrastructure, because the revenue cost to the federal government may substantially exceed the interest-cost subsidy provided to the state and local governments.

How Is Funding for Highway Infrastructure Provided, and What Are Some Alternatives?

CBO tracks the status of the Highway Trust Fund, an accounting mechanism in the budget for recording certain federal spending for highways and transit systems and collections of certain transportation-related taxes. Although the Fixing America’s Surface Transportation (FAST) Act transferred about $71 billion to the Highway Trust Fund in fiscal year 2016, mostly from the Treasury’s general fund, CBO projects that the Highway Trust Fund’s revenues will be insufficient to meet its obligations by 2021. CBO has observed that the treatment of surface transportation programs in the federal budget is unusual and the way those programs are classified facilitates the spending of more money from the trust fund than there are dedicated revenues to support such spending.

Policymakers may want to consider who should decide how the money is spent, how to pay for the infrastructure, and other questions about spending and funding for highways. In thinking about alternative approaches to highway funding, CBO has focused on fuel taxes and on taxes that could be assessed on the basis of the number of miles that vehicles travel.

If Policymakers Wanted to Encourage Private Investment in Infrastructure, How Could They Do That?

Some observers believe that public-private partnerships could increase the funds available for infrastructure projects, get them finished more quickly, or reduce their cost. To encourage those arrangements, some analysts and policymakers have suggested the creation of a federal infrastructure bank.

CBO has found that private financing would probably increase the funds available for highway construction only when states or localities have restricted their spending by imposing legal or budgetary constraints on themselves. The reason is that revenues from the users of roads and from taxpayers are the ultimate source of money for highways, regardless of the financing mechanism chosen. An infrastructure bank could play a limited role in enhancing investment in surface transportation projects by providing new federal subsidies (in the form of loans or loan guarantees) to a limited number of large projects. But only some projects would be good candidates for such funding, because most do not involve tolls or other mechanisms to collect funds directly from their users or beneficiaries.

Chad Shirley is CBO’s Deputy Assistant Director for Microeconomic Studies.