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Infrastructure After COVID-19: Risk Of Another Lost Decade Of U.S. State Government Capital Investment

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Infrastructure After COVID-19: Risk Of Another Lost Decade Of U.S. State Government Capital Investment

S&P Global Ratings' analysis of the decade following the Great Recession shows a decline in state capital spending and infrastructure investment. This new paradigm was due to a number of factors, but mostly reflects a challenging operating environment and growing fixed-cost obligations, like pensions and other benefit costs through the lower-for-longer recovery period. Over the past decade, S&P Global Ratings estimates the U.S. would have spent approximately $1.5 trillion more in state and local government infrastructure investments had it continued on its pre-Great Recession path. During this period, both state debt and the portion of budgets devoted to capital expenditures declined. As the country emerges from the COVID-19-induced recession, U.S. state infrastructure spending is likely to be disrupted further. One consequence of continuing travel restrictions instituted to control the spread of the virus is that billions of dollars in transportation-related revenues, which typically fund long-term capital plans, are at risk of falling short of pre-pandemic levels, possibly for several years. As the country begins to recover from the COVID-19-induced recession, which was even more severe than the Great Recession, we see a growing risk of continued underinvestment in infrastructure.

Chart 1

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Federal fiscal support that included programs to spur infrastructure investment was vital following the Great Recession to prevent a steeper drop-off in capital investment, but there has been no agreement in Washington on a new comprehensive infrastructure plan. The temporary one-year extension of the federal FAST Act was a start, but only maintains the status quo and does little to promote additional spending. Absent additional federal support, or a quick recovery in state revenues, the U.S. faces another potential decade of missed infrastructure investment.

What Was Lost: $1.5 Trillion In State And Local Infrastructure Investment

Based on a simple linear regression of BEA data, S&P Global Ratings estimates that if state and local government investment continued at a rate prior to the Great Recession, $1.5 trillion more in infrastructure spending would have occurred from 2009 to 2019. This missed opportunity contributed to a decade of slower economic growth, missed productivity gains, and deferred maintenance that increases the costs of deferred capital projects.

Chart 2

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While the sudden and severe onset of the COVID-19-induced recession created new budgetary challenges, it also provided an opportunity for renewed infrastructure spending. S&P Global Economics estimates that a $2.1 trillion boost in public infrastructure spending over 10 years, to the levels (relative to GDP) of the mid-20th century, could add as much as $5.7 trillion to the U.S. over the next decade, creating 2.3 million jobs by 2024 as the work is being completed (see, "Infrastructure: What Once Was Lost Can Now Be Found--The Productivity Boost," published May 6, 2020, on RatingsDirect).

What Changed: States Deleveraged And Spent Less On Capital Investments

By most accounts, the immediate past economic recovery was shallow with economic growth only starting to accelerate in 2018 (see "When The Credit Cycle Turns, U.S. States May Be Tested In Unprecedented Ways," published Sept. 17, 2018). Fueled by aging demographic profiles and updated actuarial assumptions, growth in spending on Medicaid, pension contributions, and retiree health care benefits increased faster than overall expenditures, eroding states' discretionary expenditure capacity. As a consequence, capital investment waned as an abrupt change in spending policy created stress for state budgets. During this time, S&P Global Ratings generally observed:

  • A slower rate of increase in long-term state and local government debt as pension pressures worsened;
  • Smaller portions of state budgets devoted to capital expenditures; and
  • New efforts to bolster transportation-related revenues to fund infrastructure projects.

Long-Term State And Local Debt Declined As The Economy Grew

As pension valuations recognized the stock market losses of 2008-2009, liabilities on state and local government balance sheets ballooned and future annual contribution increases were expected to exceed revenue growth. Across the country, pressure increased to curb these increasing costs as they threatened to consume more discretionary budgetary flexibility (see "Recent U.S. State Pension Reform: Balancing Long-Term Strategy and Budget Reality," published Feb. 9, 2018).

From 2010 onward, state and local unfunded pension liabilities continued to grow from 19% to 23% of gross state product (GSP) before declining in 2017. At the same time, long-term debt steadily fell from 19% to approximately 15.5% of GSP. The slower rate of growth of long-term indebtedness is, in our opinion, partly due to increasing pension liabilities and associated contributions.

Chart 3

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We view efforts to address rising pension liabilities positively, but this had the unintended consequence of reducing capital spending. On a positive note, the progress states have made on reforming pension obligations reduces its significance as a near-term effect on most state budgets. In our recent survey of state pension plans, we continued to observe states adopt more conservative actuarial assumptions and methods or direct resources into pension plans above required contributions (see "Sudden-Stop Recession Pressures U.S. States' Funding For Pension And Other Retirement Liabilities," published Aug. 3, 2020).

The Portion Of State Budgets Devoted To Capital Spending Continued Its Decline

Capital expenditures as a percentage of state budgets declined from 13% to 8% from 1991 to 2019, underscoring a shift in state spending priorities even before the Great Recession. In turn, new revenues have largely been used to maintain, not grow, infrastructure programs as the nation's transportation infrastructure aged.

Chart 4

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This trend is worrisome for the long-term readiness of U.S. infrastructure and demonstrates increased deferred maintenance. In our opinion, significant underspending on maintenance can reduce asset life and increase capital costs, pressuring future financial flexibility (see "Between A Budget And A Hard Place: The Risks Of Deferring Maintenance For U.S. Infrastructure," May 15, 2018). Continued failure to maintain and invest in infrastructure could also lead to slower economic growth or public safety lapses.

Pay-As-You-Go Financing Became More Popular As Federal And Bond Funds Waned

With most capital expenditures occurring outside of the general fund, there has been a noticeable decline in the amount of federal and bond funds spent on infrastructure. According to our analysis of data collected by the National Association of State Budget Officers (NASBO), bond funds financed only 27% of state capital expenditures in fiscal 2019, down from a high of 33.5% in 2009. Over the past 10 years, capital expenditures from federal and bond funds have declined while spending from other state funds, such as revenues in highway and transportation trust funds, increased.

Chart 5

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Since the Great Recession ended, many states proposed or enacted changes to their motor fuels taxes. This mostly occurred after 2014, when a global decline in the energy sector left states with such taxes tied to energy markets undergoing automatic gas tax rate declines. Tolling has also part of the conversation in statehouses recently, where entirely new methods of taxation to fund infrastructure have been under consideration (see, "As U.S. State Debt Levels Moderate, Transportation Funding Takes Center Stage," published June 11, 2019). New transportation revenues offset declines in federal and bond funds, but COVID-19 and the sudden-stop recession threaten a pullback in spending.

What's At Risk: Future Infrastructure Investment And Transportation-Related Revenues

Chart 6

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With dramatic declines in revenues expected, states will likely pull back on discretionary capital spending to alleviate budget stress. S&P Global Ratings has already observed states significantly reducing expenditures and deferring capital expenditures to address budgetary imbalances (see "COVID-19 Induced Recession Throws Curveball To U.S. State Budgets," published May 21, 2020, and "U.S. States Mid-Year Sector View: States Will Continue To Be Tested In Unprecedented Ways," published July 13, 2020). In our opinion, however, Federal infrastructure stimulus and additional state debt issuance may prevent steep declines in capital spending like we observed in the years following the Great Recession.

State transportation funds receive a number of related revenues, the bulk of which are motor fuels taxes and other vehicle fees, to fund infrastructure programs. Over time, we have observed many states reform their transportation-related revenue structures in response to changing economic trends and consumer behavior. For the past few years, states have generally seen revenue growth in their transportation funds. However, travel restrictions in an effort to mitigate the spread of COVID-19 are placing pressure on these revenue sources and capital programs.

Chart 7

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The effect of health and safety mitigation efforts on transportation-related revenues is directly observed in monthly miles traveled and vehicle sales. Total vehicle sales declined 47% from February to April 2020, along with a similar drop of 56% in vehicle miles travelled from February to May 2020 before increasing as parts of the country began to ease travel restrictions. It is unclear when travel will resume at pre-recession levels as broader market changes occur.

Chart 8

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The COVID-19 pandemic has dramatically affected the global transportation industry like no other disruptive force in modern history. In three months, the precipitous decline in public transit ridership, cruise ship sailings, air traffic, parking, toll road transactions, port container volumes, and overall mobility--up to 95% in some subsectors--has contributed to an expected slow recovery following the sudden-stop recession and the sharpest contraction in economic activity following World War II (see "Activity Estimates For U.S Transportation Infrastructure Show Public Transit And Airports Most Vulnerable To Near-Term Rating Pressure," published June 4, 2020).

Federal Fiscal Stimulus Could Prevent Further Capital Spending Declines

As we have observed in other recessions, countercyclical federal funding has had a stabilizing influence on state credit quality. In total, Congress approved approximately $1.5 trillion in fiscal stimulus legislation from 2008 through 2012. A landmark stimulus program of the Great Recession, the American Recovery and Reinvestment Act (ARRA) of 2009, provided $48.1 billion for programs administered by the U.S. Department of Transportation ($27.5 billion of which was authorized for highways) to aid the economy over the long term. However, as the stimulus from ARRA faded, the Congressional Budget Office (CBO) also noted that 2013 saw the lowest spending on major infrastructure systems since the late 1990s.

State and local expenditures make up around 75% of national transportation infrastructure expenditures, according to the CBO. Without federal fiscal support following the Great Recession, the drop-off in capital investment would likely have been more severe. Nonetheless, even during normal federal budget cycles, a recurring issue has emerged with federal funding of transportation projects falling short of receipts in the highway trust fund (HTF).

Chart 9

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The CBO estimated in March that the HTF faces a shortfall of $87.8 billion in fiscal 2021-2025 and a $120.7 billion shortfall in fiscal 2026-2030. Without a reduction in the size of the surface transportation programs, an increase in revenues, or further general fund transfers, the HTF will become insolvent, threatening infrastructure programs across the country. Funding of the HTF shortfall has often been done in five-year increments, the most recent of which was set to expire Sept. 30, 2020. Identifying a replacement revenue source for existing federal gas tax remains a key uncertainty in achieving a long-term solution, and in the interim, general fund monies have been used. Whereas this is a positive in sustaining the federal role in national infrastructure investment, it is likely not a long-term solution. While Congress passed a continuing authorization extending the FAST Act one more year, a long-term solution remains unclear.

To possibly not repeat the lower-for-longer pace of recovery following the Great Recession, a new federal program for infrastructure spending--now--would alleviate some pressures on state budgets and ensure necessary capital programs are not delayed further. While some extraordinary aid has already been authorized to address direct expenditures related to the pandemic, along with additional Medicaid matching funds, it is unclear if future aid, particularly for infrastructure investment, will be authorized.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Timothy W Little, New York + 1 (212) 438 7999;
timothy.little@spglobal.com
Secondary Contact:Geoffrey E Buswick, Boston (1) 617-530-8311;
geoffrey.buswick@spglobal.com

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