As outlined in Chapter 5 of the 1967 Budget Report, the foundational principle of FCRA is that a federal loan has a substantive non-federal source of repayment. The loan is an outflow, like other federal payments. But repayment from non-federal sources is an inflow that reverses, to a precisely calculated extent, the initial outflow. Recording such reversing cash flows as expenditures and revenues would seriously distort the federal budget. Hence there is FCRA, which records federal loans on an accrual basis in accordance with well-established financial accounting procedures. It is not mysterious, nor much open to gaming, which is unsurprising since the sole purpose of enacting such special treatment for federal credit was to prevent budget games.
A substantive non-federal source of repayment is something that should be straightforward to establish objectively. It’s worth noting, however, that another federal inflow also comes from non-federal sources — federal taxes. The difference is that in a federal loan the repayment obligation is undertaken voluntarily, and loan proceeds are used (within the limits set by the loan program) in the borrower’s own self-interest. In contrast, the federal government uses its sovereign power to force tax inflows from non-federal sources and allocates the proceeds to general public goods. The former process is recorded under FCRA, the latter exclusively in the federal cash budget. The distinction is important, but I think in the overwhelming majority of federal loans it will be so glaringly obvious as to not require much, if any, confirmation.
Non-Federal Cost Shares in an Honest Land
As discussed in a recent post, FCRA Non-Federal Issue: A New Approach, federal loans for non-federal cost shares in federally involved infrastructure projects are a bit more complicated because the borrower’s self-interest is mixed with federal interests. But in an honest land, the distinction between a non-federal source’s repayment of a federal loan and payment of federal taxes should be abundantly clear even in a cost share financing.
In a normal deal, the non–federal interest may be complex, but the character of a FCRA-classified repayment (versus federal taxes) can be determined from an examination of the non-federal borrower side alone. Did they voluntarily agree to undertake the loan’s repayment obligations in order to pay for the cost share? Did they get specific, commensurate value for themselves? If ‘yes’ to both, the cash inflows to the federal government from the borrower are voluntary and self-interested. They can’t be recorded as taxes and instead belong under FCRA.
A World Devoid of Crooks?
The lapidary amendment language in HR 8127 and HR 2671 appears to be assuming that with respect to FCRA classification, the world is necessarily an honest and straightforward place. That’s somewhat understandable. Aren’t the reversing cash flows from a non-federal repayment source in themselves sufficient to force the loan into FCRA, whether or not anyone wants that, per the section’s founding principle and anti-gaming purpose? All the relevant facts confirming a non-federal characterization of the loan’s repayment source will certainly be surfaced by the credit rating agency’s extensive review. Plenty of other mischief might be occurring in the deal, but how could any of that alter such visible and objective facts?
Sadly, under current WIFIA law, I can see a way that crookedness could result in FCRA misclassification, not as a primary goal but rather as a minor side effect. This is because even manifestly non-federal sources apparently repaying a federal loan might in effect be paying federal taxes.
There are two varieties of a con that have this effect, both involving federal sovereign power, the unique factor in non-federal cost shares in federally involved projects. The first was described in the New Approach post. If an unethical federal participant leans on a non-federal source to pay for a share in a project they don’t want or find beneficial, the source is being forced through the misuse of sovereign power to pay for a federal asset, which might even look like a national public good. The payment is an unauthorized yet de facto form of federal taxation, and if there’s a federal loan in the middle, all loan repayment will in effect be federal tax payments, too. The transaction doubtless belongs in criminal (or in less extreme and more realistic cases, civil) court, but for as long as it stands, it should be recorded in the federal cash budget, and the loan can’t be classified under FCRA.
The second variety works the other way around. A non-federal crook bribes the federal participant with some unrelated quid-pro-quo to deliver to its cost share an amount of value far in excess of what the non-federal source pays. The federal participant redirects resources from tax sources to create the excess value. The cost-share payment, such as it is, can be seen as a minor, on-the-books part of the purchase price for a redirection of federal taxing power. Hence, the payment is primarily related to federal tax, not the project. I have no idea how this would be recorded in the federal cash budget prior to various well-deserved indictments, but that’s where it belongs. Definitely not under FCRA.
I hope this kind of thing is vanishingly rare. I assume it is for large scale infrastructure projects. Nevertheless, the theoretical possibility of a misuse of federal sovereign power shows that a non-federal source of repayment is a necessary but not quite sufficient condition for the FCRA classification of a federal loan to finance a cost share in a federally involved project.
A World Full of Imbeciles?
The current WIFIA Criteria don’t appear to be too concerned about crooks. Instead, they apparently assume that the world is full of imbeciles.
The so-called Criteria determine, through a series of questions and an undisclosed process (that may or may not include actual criteria), whether the project or asset being financed by the federal loan is ‘federal’ or not. The asset’s value and utility with respect to loan amount or the borrower’s motivation don’t seem to be relevant. Instead, the objective appears to be an accounting classification along the lines of subsidiary consolidation per private-sector GAAP. In a cost-share situation for a large infrastructure project, there will be many undivided and intangible assets where federal and non-federal interests interact in complex ways, but the Criteria assume the whole thing to be ‘federal’ unless proven otherwise, apparently beyond the slightest shadow of doubt. I think we know how that will turn out. The Criteria publication helpfully notes that cost shares in USACE or Bureau of Reclamation projects needn’t bother to go through the process at all — they’re simply presumed to be ‘federal’.
I’ve discussed this rabbit hole in several prior posts, most directly here. For this one, I’ll focus on the bizarre implications of the Criteria classifying (however erroneously) a cost share as a ‘federal’ asset with respect to the characterization of the loan’s proposed non-federal source of repayment. In one sense, this is an academic exercise, since the inevitable ‘federal’ classification of the cost share will result in immediate rejection of the loan application, likely the intent all along. Still, the implications are worth considering, not so much to add to the list of the Criteria’s shortcomings (they’re damning enough already), but as context for some aspects of the Criteria’s possible replacement. It’s also oddly amusing, to be honest.
Most glaringly, the non-federal participant will certainly be very surprised to learn that the cost share it planned to finance with a WIFIA loan won’t actually be theirs, but a ‘federal’ asset instead. All those months and years of planning and analysis about the critical value the cost share will provide to the community and investors? All those hard-fought negotiations with a federal participant vigorously defending federal interests? All those presentations, public meetings, council approvals and voter referenda about investing a large amount of money into an important infrastructure project? Stacks and stacks of contract documents, engineering studies and benefit-cost analyses detailing tangible and intangible value, precisely defined undivided interests and countless rights and obligations?
Delusional! Pointless! The Criteria have determined that there is no non-federal asset in this project! What you thought was yours is in fact a national public good! You get nothing!
Since the Citeria have pronounced that WIFIA loan proceeds applied to the putative non-federal cost share will in fact be paying for a national public good, loan repayment will be a form of federal taxation, as in the case of federal extortion described above. Interestingly, extorted federal taxes should get the same treatment in the federal budget regardless of the method of payment — illicit or not, they’re tax revenue, pre-indictment anyway. But unwitting federal taxes apparently do not. If the non-federal participant paid for its cost share in cash upfront or financed it in the federally subsidized tax-exempt bond market, presumably the payment to the project would not be recorded as revenue in the federal budget, perhaps being only indirectly reflected as a reduction in the federal participant’s budget for project cost.
However, if the non-federal participant financed the same cost share with a WIFIA loan (theoretically speaking, of course), the Criteria would spring into action and in due course discover a new ‘federal’ asset that (per cash accounting) can only have been paid for by, well, federal tax revenue. Specifically, the WIFIA loan’s principal amount would (via a 100% credit subsidy) be a tax expenditure for the new-found asset, to be balanced by a new federal tax revenue stream that covers the full cost, even including UST interest on the initial deficit financing. Substantively, WIFIA isn’t really making a loan (all the initial flows are now intra-federal) but acting as a tax collection agency specializing in long-term contracts that deliver new revenue in the nominal form of ‘loan repayment’.
In a twisted way, this actually doesn’t sound so bad for the federal government. If the Criteria’s agency operators really believe that the proposed non-federal cost share is a federal asset that an imbecile is willing to pay additional taxes for, and that this reality is uniquely surfaced for inclusion in the federal budget by said imbecile’s use of WIFIA financing, why aren’t they encouraging it?
As I said, bizarre. Isn’t this the kind of budget game-inducing irrationality that FCRA was enacted to prevent?
Back in the Real World, Common Ground
Of course, the proponents of the amendment in HR 8127 and HR 2671 know that no technical financial classification or definition can be completely crook-proof, especially when there’s big money involved. My guess is that they simply couldn’t conceive of any concrete way that mischief could be involved in this case, and that generalized or vague restrictions would allow the worst elements of the Criteria to enter through the backdoor. The proponents’ basic sense that FCRA classification is straightforward and would be harmed by unnecessary qualifications is correct. But if shown a precise scenario for FCRA misclassification, I think they’d agree to include specific and limited criteria to address it.
Likewise, I am certain that the Criteria’s authors did not intend to imply that non-federal cost-share participants are imbeciles volunteering to pay more federal tax. Frankly, I’m not sure how much they thought through the FCRA issue or the Criteria’s consequences, other than what was required to obviate the issue by effectively denying all applications. My impression is that there was lot of confusion, not much real-world financial knowledge and some elements of a hidden agenda going on. But I believe that they were also motivated by a genuine feeling that the FCRA classification of WIFIA loan for a cost share in a federally involved project requires some extra steps, though they didn’t understand exactly why or what the steps should be. That feeling is justified. Again, if shown what’s actually required and how that would be consistent with FCRA law and principles, they (or some of them, anyway) might quietly agree to allow the current Criteria to be replaced if it can be done in a face-saving way.
The important point here is that there is non-controversial common ground, solidly based on FCRA law and principles, between the pro-amendment and the pro-Criteria sides. Both sides are partly right and partly wrong, and both can claim a win if the common ground is tacitly agreed to be the basis of a solution. If FCRA was less of an abstract and specialized area, the common ground would likely be more obvious. But it’s clearly not. The first challenge is to get there, the rest might be easier.