But the global financial crisis changed all of that. Tax revenues crashed in many jurisdictions as unemployment skyrocketed and corporate profits plummeted. As a result, government spending was summarily slashed and program funding starved. Most prominently in Europe – but also in other major economies – governments are now engaged in an ongoing life-and-death struggle to bring down their debt and stabilize their economies in the face of continued market uncertainty.
The unrelenting demand for infrastructure
Interestingly, even in the midst of stagnating national growth and high unemployment, the demand for infrastructure has not abated. Indeed, if anything, the drive to revitalize economies through infrastructure investment has only accentuated the infrastructure gap and – with it – the cost of development. For example, in Italy the new Government recently announced, alongside stringent austerity measures, a 4.8bn euros investment in infrastructure.1
As a result, many governments are increasingly looking for new and innovative ways to cover the costs of their ballooning infrastructure bills without jeopardizing their balance sheets.
One important tool in the government funding drawer is to charge consumers for their use of infrastructure, rather than taking from the tax base as a whole. Not only does this shift the costs ‘off balance sheet’ from the government's perspective (thereby freeing up fiscal capacity to focus on other priorities), it also places the burden of financing on those that receive the most benefit from the asset over its lifecycle.
Tapping the consumer purse
From a political perspective, user fees may not be the ultimate panacea to infrastructure funding. For one, surcharges tend to be strongly disliked by voters, particularly in cases where costs are increasing with no visible corresponding benefit to consumers (such as capital-intensive maintenance projects or the move to ‘greener’ yet more expensive power generation).
What’s more, many politicians see tax as a fairer mechanism than user paid charges. And while this may seem counter-intuitive, there is a general belief that taxation is essentially ‘means tested’, and therefore ensures that the greater share of the cost is shouldered by high income earners and more profitable businesses rather than struggling families or nascent enterprises.
Governments at all levels are also starting to acknowledge the real and significant difference between central taxation and local funding. And as central funding starts to dry up, cities increasingly need to take their destiny into their own hands. In India, for example, the Mumbai Metropolitan Region Development Authority (MMRDA) has unlocked a sustainable source of local funding by monetizing land values. The authority essentially recycles the proceeds of land sales back into infrastructure investment, thereby making the city growth much less reliant on central funding or consumer-pay schemes. In London, over £4bn was raised from a supplemental business rate to fund Crossrail.
Of course, the debate over who pays is deeply influenced by affordability. As a result, an increasing number of governments are starting to think about their spend in terms of the overall ‘affordability envelope’ that consumers and governments are willing to bear.
Take, for example, an average London resident. Within their affordability envelope would sit council taxes, income taxes, fuel bills, utility bills (widely expected to mushroom as renewable sources come online) and a range of other charges such as the London Congestion Charge and others. So in planning for the Thames Tideway Tunnel (a massive project designed to ease the flow of sewage out of the city), the government has to consider what is ‘affordable’ for residents and structure the overall funding accordingly.
The affordability envelope applies equally to government coffers. Today’s finance minister must balance the cost of infrastructure against a host of other priorities, some immediate (such as debt refinancing in Europe), and some long-term (the UK’s Renewable Energy Targets, for example). Add to this the rising cost of capital, uncertain economic forecasts and unrelentingly high unemployment in many jurisdictions and it becomes clear that the public affordability envelope is packed very tightly indeed.
Time for government intervention
Clearly, if governments plan to meet their infrastructure obligations, they will need to take more of a role intervening in the market to catalyze private sector capital towards financing for infrastructure. Some may choose to simply provide grants to sectors of the market that either lack proper pace or are seen as uneconomical in the near-term. Other tools may include revenue subsidies, price or volume guarantees, tax incentives or reductions. Governments will also need to place a particular focus on creating the enabling conditions for private sector investment, such as strong central planning capabilities and transparent policy.
Timing and scope of the intervention are also critical questions. Too small an intervention, and governments run the risk of achieving little for their investment (many of the infrastructure projects funded by the US economic stimulus plan in 2009 may have suffered this fate). Too large an intervention not only wastes precious budget, but may also cause bubbles in markets or create unsustainable financial obligations (such as Spain’s solar panel subsidies which were slashed in 2011).
What size an intervention?
Unfortunately, there is no magic yardstick by which to measure interventions. Indeed, judging the appropriate level of intervention is an incredibly difficult thing to do and is anything but an exact science. Much will depend on the state of the local market, the availability and willingness of private capital to invest and the pace at which the government is seeking to achieve their objectives.
Looking at funding through a holistic lens
With a variety of different funding models and payment options now on the table for governments, the ability to balance all of those sources to ensure sustainable, secure and appropriate funding within an overall affordability envelope will become a key capability for governments at all levels.
Ultimately, those countries that are able to construct their infrastructure plans in a holistic, joined-up and integrated way will stand a much better chance of responding to their infrastructure challenges... without bankrupting the country.
By James Stewart, KPMG in the UK
1 The Associated Press, 6 December 2011. Available at: http://www.businessweek.com/ap/financialnews/D9RF4R3O0.htm