Borrowing Today for the City of Tomorrow? Municipal Debt and Alternative Financing

This paper is part of the IMFG Forum Papers series. For a full list of papers, please visit http://bit.ly/2ylAa2DIn early 2013, the Institute on Municipal Finance and Governance (IMFG) hosted a two-part forum called “Borrowing Today for the City of Tomorrow.” The series, co-sponsored with KPMG, brought together academics, government officials, and market participants to discuss the role of borrowing and alternative financing mechanisms in addressing Canada’s municipal infrastructure needs. This paper, like the forum, addresses two issues: whether municipalities can and should borrow more, and the role of public-private partnerships (P3s) in addressing the municipal infrastructure gap. The key lessons from the forum are distilled under these headings. A. Can and should municipalities borrow more? Borrowing is part of the solution to Canada’s municipal infrastructure gap. The municipal infrastructure gap is too large to plug with current revenues alone and political resistance to increasing taxes, fees, and transfers is high. Moreover, the benefits of capital investments accrue over generations, but the brunt of their costs is borne by today’s taxpayer. By borrowing, municipalities can distribute the costs of assets over the life of those assets. Canadian municipalities have good access to debt capital markets. They are benefiting from low interest rates, a growing investor base, and strong demand for long-term bonds. Now is the time to borrow. But prudence remains a virtue. The struggles of several American cities and European countries demonstrate that municipal borrowing still poses risks. And borrowing is not the only means of paying for infrastructure investment. Borrowing should be balanced with efforts to enhance core revenues and limit long-term dependence on capital markets. B. Alternative financing through public-private partnerships (P3s): P3s offer several benefits and risks. P3s are contractual arrangements between the public and private sector in which the latter delivers a service or project and assumes some financing, technical, or operating risk. Potential benefits include efficient risk sharing across public and private sectors, improved performance accountability, and opportunities to leverage private-sector expertise and innovation. Potential risks include reduced policy flexibility and windfall private-sector profits. Obstacles to municipal P3s are pronounced but surmountable. Execution of local P3s is hindered by small transaction sizes, lack of local expertise, fragmented local institutions, and the openness of the local approval process. Many municipalities, however, have successfully addressed these challenges. Canada’s approach to P3s provides distinct advantages. Canadian P3s transfer limited risk to the private sector. Canadian governments reserve the right to deduct payments for poor performance, but do not place a heavy onus on the private sector to generate project revenues. This approach shifts a greater proportion of project costs onto taxpayers, but reduces the risk of project failures. But concerns remain about the transparency of the pricing of project risk premiums. Despite incurring relatively few risks, the private sector is often paid significant risk premiums. Although these premiums may reflect objective project risks, it is difficult to know for sure given the opacity of the pricing process