Public-Private Partnerships for Transportation and Water Infrastructure

Federal, state, and local governments spent $441 billion on transportation and water infrastructure in fiscal year 2017, and there is widespread demand for greater investment. All levels of government face calls to improve highways and other transportation systems and to make drinking water and wastewater systems safer and less expensive for users. Some analysts have suggested that public-private partnerships might contribute to those improvements by providing private parties with incentives to complete projects more efficiently—in less time or at lower cost. Other observers have noted that public-private partnerships that include private financing could contribute to the financial resources used for transportation and water infrastructure. Such partnerships, however, impose costs on the federal government when they draw on federally supported financing.

This CBO report explains the differences between the use of public-private partnerships for transportation and those for water infrastructure. It determines whether partnerships without financing build projects more quickly or less expensively for taxpayers. Finally, it assesses whether partnerships that included private financing sped up the financing process.

What Are Public-Private Partnerships, and How Are They Used for Transportation and Water Infrastructure?

Traditionally, state and local governments have hired private firms as contractors responsible for a single stage of a project, such as construction or maintenance. In a public-private partnership, however, the private partner is responsible for multiple stages of a project—among them may be designing, building, financing, operating, and maintaining the infrastructure—in a way that transfers risks to the private partner and creates incentives for that partner to be efficient. Those risks can include the possibility of cost overruns, delays in the construction schedule, or shortfalls in a project’s revenues.

In a partnership that uses private financing, the private partner is generally compensated in one of two ways:

• In some cases, partnerships that use private financing have been repaid with payments from the state or local government as the private partner builds or maintains a highway in a way that meets performance criteria specified in the partnership contract.
• In other instances, such private financing has been repaid with revenues generated by fees, such as highway tolls, from infrastructure users.

In either case, the private partner’s profit depends on the project’s success, which increases the private partner’s incentive to achieve the best outcome at the lowest cost.

Under other kinds of arrangements, payments to the private partner are effectively guaranteed regardless of a project’s outcome; because no risk is transferred, CBO does not consider such arrangements to be public-private partnerships. Such instances are essentially third-party financing: The private entity lends money to a government in lieu of the government’s borrowing by issuing bonds.

Public-private partnerships that provide transportation and water infrastructure are uncommon in the United States. They have represented just 1 percent to 3 percent (depending on the type of infrastructure) of such projects since the early 1990s. Highway partnerships, particularly those that involve private financing, have become more common since the late 2000s. Private financing has also been used a few times recently for other kinds of transportation projects, such as airports and transit and commuter rail facilities. Public-private partnerships for municipal water utilities (facilities that provide drinking water and handle wastewater) began to be used more frequently in the late 1990s, when the Internal Revenue Service (IRS) loosened restrictions on private contracts for operation and maintenance activities. Their use has since leveled off.

How Can a Public-Private Partnership Affect an Infrastructure Project?

A public-private partnership can increase a private entity’s incentive to achieve the best outcomes at the lowest costs relative to a traditional arrangement, but a public-private partnership also risks negative consequences for taxpayers. By consolidating responsibility for two or more stages of a project in a public-private partnership, the private partner has greater incentive to incur up-front costs that ensure the facility’s longer-term performance. Effective consolidation of such responsibility requires a carefully written contract that allocates some risk to the private partner. Consider a private partner that is paid a fixed fee for both building and maintaining a facility. To minimize the risk of high maintenance costs, the private partner may choose to use more expensive but longer-lasting construction materials than if it were paid a fee for only building the facility, as might happen under a traditional contracting arrangement. Through such channels, public-private partnerships can lower costs to taxpayers. However, in some cases, poorly written contracts have led to unfavorable outcomes for users and taxpayers. Such outcomes include private entities’ interpreting contract terms in a way that allowed those entities to charge higher tolls or water use fees than were initially anticipated. In other circumstances, state and local governments were restricted from making necessary improvements to competing facilities.

The total cost of a public-private partnership does not depend on whether its financing is provided by the public sector or the private sector. If financing is provided by the public sector, the taxpayers directly bear the cost of servicing any debt and indirectly bear the cost associated with the risk that the value of the infrastructure will be unexpectedly low (or high) relative to the cost of the financing. If the private sector provides financing, those costs are shifted but do not disappear. The private entity expects a return to compensate for bearing those risks. Because that compensation comes through government payments and user fees, taxpayers or users of the infrastructure ultimately bear the costs. However, different financing arrangements can shift costs among different taxpayers and the private partner. For example, for a state or local government, the cost of tax-exempt borrowing is lower than the cost of private financing because federal taxpayers subsidize borrowing through tax-exempt bonds. In addition, different financing arrangements are subject to different external constraints. For example, many state governments have budgetary limits or legal constraints that limit their ability to issue debt.

What Has Experience Shown About Partnerships?

The past three decades of experience with infrastructure partnerships indicates that they tend to be used differently for different types of infrastructure. In highway partnerships, a private partner more often is paid by the government and is responsible for work that combines design and construction, after which the government then operates and maintains the highways. In water utility partnerships, the private partner more often is paid by user fees and is responsible for the combination of operation and maintenance.

Studies show that highway partnerships have slightly reduced the average length of design and building phases and slightly lowered costs on average for taxpayers. However, the data are limited, and it is difficult to evaluate what the experiences would have been without the partnerships. In addition, private financing has probably helped accelerate projects in some states by providing financing more quickly than under more traditional arrangements such as public debt offerings. But highway partnerships have also resulted in bankruptcies, canceled projects, and delays. For example, unexpectedly weak highway toll revenues in the wake of the 2007–2009 recession led to a spate of bankruptcies among private partners that provided private financing.

Perhaps as a result of those experiences, in the past decade highway partnerships have generally transferred less risk to private parties than in previous decades. In particular, from 1993 to 2008, 83 percent of the financing for privately financed highway projects was to be repaid with toll revenues collected by the private partner. Since the 2007–2009 recession, that figure has declined to 56 percent. During those same periods, the share of private financing that was to be repaid by a state or local government increased from 17 percent to 44 percent. Similarly, among projects that included private financing, there was an increase in the share of total financing that was federally subsidized. From 1993 to 2008, 25 percent of the financing of such projects came from tax-preferred bonds or direct lending by the federal government. After 2008, 49 percent of the financing was federally subsidized.

Unlike highway partnerships, partnerships for water utilities have focused more often on long-term operation and maintenance instead of construction. Private partners have often helped bring a utility into compliance with the Environmental Protection Agency’s (EPA’s) regulations. Some studies show that such partnerships have achieved cost savings for taxpayers relative to traditional arrangements. Nonetheless, partnerships for water utilities remain rare. Several factors have probably helped limit such partnerships. Those factors include concerns about fee increases by private partners, difficulties in foreseeing contingencies, and the availability of options for reducing costs and improving outcomes without giving up public control.