State debt levels remain moderate despite many states experiencing increasing revenues following the last recession and the 2017 Tax Cuts and Jobs Act. However, S&P Global Ratings has observed a renewed focus on transportation projects as states consider taking on new debt, reform transportation-related revenues, and increasingly consider public-private partnerships (P3s) or other alternative delivery methods to fund their infrastructure needs. In particular, we expect state governments will evaluate all options-–including tolling–-as they look to expand infrastructure spending in 2019, particularly as federal funding remains uncertain.

Despite this renewed focus on transportation funding and need for critical infrastructure investment, in total, we do not expect a significant increase in overall state debt levels.

Table 1

Moderating Debt Levels Are A Missed Opportunity For Infrastructure Investment

As the nation's rate of economic growth is likely to moderate, greater investment in infrastructure by states could be among the responses to offset or help reverse this trend. Solid U.S. economic growth in 2018 provided a stable base for state and local governments and projections indicate this should continue, albeit at a slower pace this year (see our report "Summer Should Be Smooth Sailing For U.S. State And Local Governments, But There Could Be Waves Ahead" (published April 30, 2019, on RatingsDirect). Although the chance of a recession as projected by S&P Global Ratings economists remains low at 20%-25% over the next 12 months, it has been increasing over the past year.

State spending on debt service has remained relatively level, despite a noticeable decline in infrastructure and other capital expenditures. According to the National Association of State Budget Officers (NASBO), bonds financed only 28% of state capital expenditures in fiscal 2018, with the rest funded on a pay-as-you-go basis (see chart 2). Over the past 10 years, capital expenditures from federal funds and bonds have declined while spending from other state funds, such as revenues in highway trust funds, has actually increased. As the nation's transportation infrastructure ages, new revenues have largely been used to maintain, not grow, infrastructure programs.

Chart 1

Transportation spending accounted for 8% of total state expenditures in fiscal 2018 (capital and noncapital), according to NASBO, increasing 6.5% over the prior year compared to only a 2.1% increase from 2016 to 2017. Other state funds, which typically earmark revenue sources such as motor fuels tax, accounted for 61.2% of total transportation funding, while federal funds were at 29.1% and bond funds at 6.4%.

While state revenues have recovered at levels below those of past economic cycles, fixed costs for pensions, other postemployment benefits, and state-funded Medicaid costs have been increasing. The revenue and expenditure pressures for states, along with uncertainty at the federal level, have made it increasingly difficult for states to allocate funding for transportation projects. (For more information, see our report, "Between A Budget And A Hard Place: The Risks Of Deferring Maintenance For U.S. Infrastructure," published May 15, 2018.)

Federal Infrastructure Policy Uncertainty Creates Pressure For States

An area of continued uncertainty at the federal level is infrastructure policy. While leaders in both major political parties say that a national infrastructure plan is needed for the country's deteriorating roads, bridges, and railways, there is a lack of agreement on how to fund such an initiative. Whether to use new taxes, P3s, and other mechanisms will be a contentious negotiating point. (See "Transportation Infrastructure 2019 Sector Outlook: Mostly Stable, Despite Expected Slower Growth And Unlikely Investment Package," published Jan. 17, 2019.)

Chart 2

One of the largest infrastructure projects in the country in need of federal funding is replacement of the Gateway Tunnel. The federally owned tunnel connects the rail network between New York City and Newark, N.J. under the Hudson River. It has been deteriorating for years, but was significantly damaged after Hurricane Sandy in 2012. The project costs are estimated at over $30 billion and increasing annually. A 2015 framework agreement among the U.S. Department of Transportation, the State of New York, and the State of New Jersey, indicated that the federal government would contribute 50% of the costs. However, the project has been put on hold by the current presidential administration due to lack of committed federal funding. In our opinion, if the tunnel's condition were to deteriorate to a point where it was too dangerous to use, it would have significant negative effects on the economic activity of neighboring states and the broader New York City metro region.

For over a decade, California has been constructing a high-speed rail line between Los Angeles and San Francisco. While the governor has proposed $23.5 billion of transportation spending in 2020, an increase of $1.4 billion (or 6%) over estimated expenditures for the current year, the spending plan reduced the state's anticipated appropriation for the project. California has appropriated $666 million for the High-Speed Rail Authority (HSRA) in 2020, a decrease of $944 million (or 59%) below the 2019 estimate.

Approved by voters in 2008, the project included a $9 billion bond to launch construction. Costs are estimated at $77.3 billion, a $13.1 billion increase over the 2016 cost estimate, with the HSRA only securing approximately one-third of the total funding needed. In his first State of the State address, the governor announced that portions of the project would be postponed. Under an American Recovery and Reinvestment Act (ARRA) funding agreement, if the HSRA does not complete the extensions to Merced and Bakersfield (estimated at $20 billion to $23 billion) by 2022, the state could be forced to pay back $3.5 billion in federal grants. Additional federal funding is unlikely as the Federal Railroad Administration announced that it terminated a 2010 agreement with the HSRA and will pull a nearly $929 million federal grant, though the state may appeal that decision.

While sometimes the victim of political stalemates and delays, federal transportation grant-secured obligations remain a highly rated source of funding for state and transit agencies (see our report "Despite The Risk Of Shutdowns, GARVEE Bonds Continue Benefiting From Government Support," published Feb. 28, 2019). The ratings on grant anticipation revenue vehicle (GARVEE) bonds assume that the supportive legislative framework and Congressional appropriations funding transportation grant programs will continue through multiyear authorizations or ongoing temporary extensions. While reauthorization risk cannot be eliminated, it has been minimized through conservative financial structures inherent in rated GARVEE transactions.

Federal debate has also brought increasing focus to long-term transportation asset resiliency, an ongoing credit risk that will likely add to capital requirements. These rising costs are partly due to increasing exposure to extreme weather and initiatives to reduce carbon emissions. Over the past year, the relationship between infrastructure and sustainable transportation investments gained prominence as a policy component of Congressional Democrats' "Green New Deal" to reduce carbon emissions and create jobs. While support at the federal level for any infrastructure investment package has been challenging--and the Green New Deal has yet to gather significant political momentum and is essentially a non-starter with the current administration--we anticipate state and local governments will increasingly focus on enhancing transportation-related projects to meet sustainable carbon-reduction initiatives.

Over the long term, the continued lack of federal funding for critical infrastructure projects and suspended agreements indicate states may need to bear more of the cost for transportation projects. Persistent federal funding uncertainty further highlights Washington's changing fiscal relationship with states and the need for states to identify new revenues for transportation projects.

States May Fund Transportation Projects By Increasing Gas Taxes, Tolls, And Other Revenue Sources

The need for new transportation-related revenues is partly a symptom of the general crowding out of government budgets by fixed obligations and the reality that, following the Great Recession, GDP growth has been sluggish. Since the last recession ended, we have seen states propose or enact changes to their motor fuels taxes, especially 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.

According to NASBO, seven governors this year (many in the Midwest) are proposing increases in state gas tax rates, while 26 other states have already raised their motor fuel tax rates since 2013. (For more information, see our report, "U.S. States Take Advantage Of A Prolonged Economic Expansion," published May 16, 2019.)

Legislation enacted this year includes Alabama increasing its gas tax rate six cents in September as part of a 10-cent phase-in over three years, before implementing a variable-rate formula in 2023 where the tax rate will be adjusted based on changes in the National Highway Construction Cost Index. Additionally, Ohio will raise its gas tax 10.5 cents and its diesel tax 19 cents this July 1, while Illinois approved a doubling of its gas tax rate to 38 cents per gallon from 19 cents, with further increases tied to inflation beginning July 1.

Tolling is also part of the conversation in statehouses, where entirely new methods of taxation to fund infrastructure needs are under consideration. The governor of Connecticut has proposed reinstating highway tolls to finance road infrastructure (major Connecticut highway tolls were removed in the 1980s), while a few years ago, Rhode Island imposed new tolls on commercial traffic, but not on passenger vehicles. This May, Florida approved three new toll roads to boost transportation funding, despite earlier actions by lawmakers to reduce toll rates. Some states, such as Oregon, have looked into demonstration projects for alternative road fund financing, such as testing geolocation devices that could track car mileage for taxing miles traveled.

New York State's fiscal 2020 budget enacted what could be a significant capital funding solution for the Metropolitan Transportation Authority (MTA), the nation's largest transit system. For several years running, MTA, state, and city officials identified congestion pricing as the key solution for the MTA's significant capital needs and growing surface street congestion. Now approved as part of the state's enacted budget, albeit with specific details still pending, the large-scale city congestion pricing plan will be the country's first. Some estimates are that the plan could generate $1 billion annually, net of costs, although there are many variables and details still to be determined before officials can produce more refined projections.

Two other measures included in the enacted New York budget will also help fund MTA capital needs. The budget includes an expansion of statewide sales taxes on internet sales that could generate an additional $480 million annually, with $320 million earmarked for MTA capital. It also includes a new "mansion tax," effective July 1, with a sliding scale levied on luxury real estate properties of $2 million or more, with a maximum rate of 4.15% on properties of more than $25 million, that could generate $365 million annually for MTA capital. While congestion pricing and the other new taxes will generate much-needed funding for the authority's capital needs, how the MTA will improve funding to resolve outyear operating deficits (noncapital) remains uncertain. (For more information, see our report "Metropolitan Transportation Authority, NY Credit Could Benefit From State Budget Adoption Of Congestion Pricing," published April 4, 2019.)

Chart 4

Major State Transportation Systems Embark On New Bonding And Revenue Programs

Some states are using improving revenue profiles and economic conditions to start bond-financed capital programs or significantly increase transportation funding. The states with such programs have some of the largest state highway agency-owned road miles in the country.

Table 2

California

The most significant development last year was affirmation of the gas tax increase approved by voters in 2017 and rejection of a proposed constitutional amendment to require voter approval for any future fuel and vehicle-related tax and fee increase. The enacted SB 1 Road Repair and Accountability Act of 2017 increased the gas tax by 12 cents, raised the excise tax on diesel fuel, and imposed a new transportation improvement fee on all vehicles based on value (including a fee on all-zero emission vehicles). All together, the combination of new taxes and fees is anticipated to raise $5.1 billion annually, and we consider the election outcome consistent with broader public support in California for transportation infrastructure.

Illinois

The state approved a substantial six-year, $45 billion capital plan that finances $33 billion in transportation improvements. The bill is funded through a number of revenue increases, including a 19-cent increase of the motor fuel tax that the state projects will generate $1.2 billion per year. It also includes $675 million from various registration and title fee increases and $78 million from a five-cent-per gallon diesel fuel tax increase. The capital plan also places Illinois more in line with other states who have not only increased gas taxes and vehicle registration fees in recent years, but also routinely develop and follow long-term capital plans. Although revenue increases support the capital plan, reducing pressure on Illinois' general operating fund, higher fixed costs would likely weigh on the state's credit profile. (For more information, see our report, "Enacted Illinois Fiscal 2020 Budget Holds The Line," published June 5, 2019.)

North Carolina

In 2018, North Carolina enacted the Build NC Bond Act, a $3 billion authorization of appropriation-backed obligations of up to $300 million issued annually over the next 10 years. The bonds will be payable, subject to appropriation, from the NC Highway Trust Fund. The debt is subject to the state's debt affordability limits; each issuance has a 15-year maturity limit, and the state treasurer is responsible for recommending issuances under the program.

Texas

As Texas' economy and population continues to expand, so do its transportation capital needs. In 2015, voters approved Proposition 7 to direct $2.5 billion of net revenue from state sales and use tax that exceeds the first $28 billion of revenue for the fiscal year. The first transfer occurred in fiscal 2018 and approximately $2.25 billion is estimated to be deposited near the end of fiscal 2019. The comptroller estimates that $5 billion of Proposition 7 funding from state sales and use tax will be available for new transportation projects in the fiscal 2020-2021 biennium.

Virginia

In April 2013, the Virginia General Assembly adopted HB 2313 to provide an annual revenue source for the Northern Virginia Transportation Authority (NVTA) and the Hampton Roads Transportation Accountability Commission (HRTAC), to implement transportation projects in their respective regions. Each authority has bonding ability with pledged revenues consisting primarily of sales and use taxes. While the debt is not considered part of the state's overall debt profile, the creation of the authority allows for substantial additional revenues and transportation projects in two of the most populous regions of the state.

• NVTA: The authority's inaugural six-year (fiscal year 2018-2023) capital plan identified 44 regionally significant, multimodal transportation projects totaling $1.285 billion.
• HRTAC: The commission's six-year capital plan (fiscal year 2019-2024) totals $4.4 billion, $2.1 billion of which is expected to be funded through debt proceeds. The remaining portion of the capital improvement plan will be funded with a combination of pay-as-you-go funding and grants.

West Virginia

On Oct. 7, 2017, voters overwhelmingly approved a referendum authorizing the issuance of GO bonds totaling $1.6 billion to support highway projects. Additionally, West Virginia has identified financing plans for fiscal years 2018 and 2023 for various transportation and road fund investments that include up to $280 million in GARVEE bonds, up to $500 million in turnpike bonds, and the $1.6 billion in GO bonds. The same year the bond program was approved, the state increased its gas tax by 3.5 cents after falling to the minimum amount "floor" amount in 2014.

Regardless of increasing bonding campaigns for some, we do not expect this will have a material effect on overall state debt ratios.

Debt Levels Should Remain Sustainable For Most States

Generally, debt ratios are low to moderate across U.S. states. While we regard state debt levels as sustainable, increasing debt burdens have resulted in downgrades for some states or augmented credit pressures they currently face. Northeast states and those with larger populations or more urban areas typically have higher debt burdens than the rest of the country.

Currently, Connecticut remains the only state with a high enough debt load to trigger a one-notch downward override rating adjustment under our state rating methodology. However, we revised the state's outlook to positive in March 2019, recognizing we may raise our rating over the next two years if the currently high debt level moderates, or if we believe the state will retain currently high budget reserves through the next fiscal 2020-2021 biennium.

Connecticut's high debt override threshold was first met in fiscal year-end 2017, before the state's assumption of the city of Hartford's $540 million debt and large issuances incorporated into our 2018 debt calculations. The governor has proposed issuing an annual average of $1.7 billion of combined GO and transportation tax-supported debt in the coming biennium, compared with an average of $2.4 billion in fiscal years 2012-2019, under his "debt diet" proposal, which could begin to materially reduce future debt levels.

Table 3

Chart 5

Table 4

Related Research

• Summer Should Be Smooth Sailing For U.S. State And Local Governments, But There Could Be Waves Ahead, April 30, 2019
• U.S. Transportation Infrastructure 2019 Sector Outlook: Mostly Stable, Despite Expected Slower Growth And Unlikely Investment Package, Jan. 17, 2019
• U.S. State Sector 2019 Outlook: Caution - Slower Speeds Ahead, Jan. 8, 2019
• Despite The Risk Of Shutdowns, GARVEE Bonds Continue Benefiting From Government Support, Feb. 28, 2019
• U.S. States Take Advantage Of A Prolonged Economic Expansion, May 16, 2019
• Between A Budget And A Hard Place: The Risks Of Deferring Maintenance For U.S. Infrastructure, May 15, 2018