SRF leverage for additional loan capacity should be encouraged. If SRFs use tax-exempt debt, it’ll cost about $1 billion in lost federal tax revenues. If they use WIFIA loans instead, FCRA cost is about $100 million. Why not expand WIFIA funding specifically for this purpose?
By far the biggest item in CBO’s scoring of the DWWIA 2021 bill is the loss of federal tax revenue caused by increased issuance of tax-exempt debt. JCT is assuming that SRFs will leverage additional grant funding with tax-exempt munis in order to expand their loan making capacity. That’s a good outcome in itself. But more tax-exempt debt means less federal tax revenues, so DWWIA has an indirect additional cost of about $1 billion.
Assuming that JCT is using their static portfolio bond substitution methodology, it’s possible to reverse engineer some of the numbers likely involved in the $1 billion estimate:
The basic logic of the substitution methodology is straightforward: If the SRFs did not issue tax-exempt debt, investors would have bought equivalent taxable bonds instead to fill up their ‘static portfolios’. The federal revenue loss is the income taxes that would have been paid on these taxable bonds — a kind of opportunity cost.
Assuming a 25% tax rate (which seems pretty standard in JCT analyses), the taxable income that would result in $1 billion of taxes over ten years is about $4 billion. Next, assuming that the AAA taxable yield averages about 3.75% over the period, an average taxable bond portfolio of about $11 billion is implied. But this portfolio is built up over time, as indicated by the increasing annual revenue loss in the JCT numbers. The 2031 revenue loss number of $215 million implies a final taxable bond portfolio of about $23 billion.
That looks pretty reasonable. The tax-exempt bond issuance would follow the same pattern as the hypothetical taxable portfolio, so in effect JCT is assuming that SRFs would leverage DWWIA’s total incremental grant funding of $29.6 billion over the period with about $23 billion of muni bonds, for a total loan-making capacity of about $53 billion. That’s about $5 billion of SRF loans per year – well within reasonable water sector demand, not to mention need. The average and final leverage ratios are very conservative, as would also be expected from SRFs. The slow-to-start incremental pattern of leverage implied by the revenue loss looks reasonable as well.
Two factors might change this scoring picture. First, SRFs might not leverage their grant funding to the extent implied by the JCT numbers. This would be consistent with a historical pattern of underleveraging among the funds. It would result in a lower loss of federal revenues, but more importantly, a lower level of loans made by the SRFs. Very roughly, for every $1 of federal revenue loss, $23 of new loans by SRFs are made possible – not a bad trade-off. Clearly, SRF leverage should be encouraged despite the possible revenue loss.
Second, SRFs might leverage using WIFIA loans instead of tax-exempt debt. Tax-exempt bond rates for AAA borrowers are usually close to or even below the US Treasury rates that WIFIA offers, but WIFIA loans have other useful features, especially for SRFs that are currently unleveraged. What’s more, encouraging SRF leverage is a top priority for the Program, and there’s a lot of scope to add innovative features to achieve that objective, as discussed in this article. It would be reasonable to assume that at least some of the SRF leverage that JCT is projecting will be provided by WIFIA – it might be most of it.
When an SRF uses a WIFIA loan instead of issuing a tax-exempt bond, federal tax revenue is not lost. But the WIFIA loan will have a FCRA credit subsidy cost. For a AAA loan, the FCRA cost is usually pretty low – about 0.50% (or even less) of the loan amount. If SRFs exclusively used WIFIA loans for the leverage pattern implied by the JCT numbers, the total FCRA cost for the ten year period would be about $115 million, or an average of $10 million per year – and the $1 billion loss of federal tax revenues would be avoided, for a net savings of about $900 million.
Of course, many variables in these estimates can and will change in a ten-year period. But the basic result – for federal taxpayers a federally subsidized WIFIA loan is much cheaper than a federally subsidized muni bond for the same policy outcome – is a robust conclusion. At the very least, that ought to be considered as a pathway to pay for developing innovative WIFIA loan products for SRF leveraging. Even better: Use possible savings as a way to pay for expanding WIFIA capacity. From this example, even $10 million or so a year looks like it will go a long way.