Several provisions in the new tax bill seemingly work together to raise financing costs on local government, where 3/4's of infrastructure spending occurs, the Brookings Institute warns.

The Brookings Institute is concerned that, by increasing the cost to finance infrastructure for states and local governments, the Tax Cuts and Jobs Act (TCJA) will lower infrastructure investment. Worse, the impact may be big enough and come so quickly that it may swamp the short-term impact of any infrastructure package Congress passes in the near future—presuming it does so.

For all the focus (and real importance) of federal infrastructure, the vast majority of infrastructure occurs at the local level. As Brookings explains:

So, raising the cost to finance local projects has a directly deleterious effect on a huge majority of the nation's infrastructure. Brookings worries that the TCJA will do exactly that. “The tax cuts will make infrastructure financing more expensive for states and local governments and increase the costs to local voters of funding infrastructure through property taxes,” they argue.

Here’s how:

Another TCJA  “whammy” for the muni-market, according to Brookings, will come from the corporate rate cut. The Federal Reserve estimates that banks and insurance companies together own almost 30 percent of all municipal debt, which are tax exempt. When the marginal tax rate falls, the value of being tax exempt falls. With larger cuts on the corporate side from 35% to 21%, demand for municipal debt is likely to fall. Perhaps sharply so, worries Brookings.

Then there’s the cap on State and Local Tax (SALT) deductions, which allows taxpayers who itemize deductions on their federal income taxes to deduct certain taxes paid to state and local governments from their gross income. And, as Brookings points out, basic and many more innovative approaches to fund infrastructure capture increases in property values—which result from new infrastructure—as a source to pay for infrastructure in the first place. This can take the form of broad increases in property taxes or special property tax rate districts. By limiting the SALT deductions, cities that have their own local income and property taxes to finance their infrastructure needs will face even higher property tax costs.

This means that, unfortunately, localities with big ticket infrastructure projects will be hit the hardest. High cost markets will also be hit because the taxes of concern here are purely nominal, with no regard to relative prices. While some of the impact of the SALT deduction cap will be mitigated by various carve-outs in the new tax bills for businesses, particularly real estate businesses that allow them to continue to deduct state and local taxes, the overall impact of limiting SALT deductions will be to increase costs to citizens who fund infrastructure through property taxes.

And the SALT deduction cap will hit states with higher income taxes hardest, many of which “also have some of the oldest and most decaying infrastructure,” as Brookings points out. This will likely slow down the infrastructure investments that President Trump ran on and affirmed on election night. It’s possible that a new, separate infrastructure policy will counteract some of these negative impacts, but as Brookings notes “financial markets work quickly and the impact of the tax bill, at least in the short run, will be to make infrastructure more expensive again.”

So the tax bill places even greater demands on local budgets and it comes at a bad time.  Almost half the states faced budget shortfalls in 2017. The National League of Cities (NLC) report “City Fiscal Conditions 2017” found that rising infrastructure costs (and the diminishing ability to defer infrastructure projects) are one of the primary sources of fiscal strain on cities, with 92% of cities reporting higher costs stressing budgets. NLC’s report, which is its 32nd annual edition that began in 1986, also found worrisome deteriorating local budget health overall.

Making a bigger ask of local budgets at a time of such structural weakness seems unlikely to result in greater infrastructure investment. Decreasing investment in infrastructure is not going to help solve some of today’s most pressing challenges and stimulate greater economic growth. At a moment of incredible evolution in our economy, and with trillions of dollars in deferred maintenance, now is the time to surge infrastructure investment. It's something seemingly every candidate agreed on in the last election, especially President-elect Trump.

Every day the U.S. delays only adds to a massive pile of lost potential bleeding the economy in the form of wasted fuel, time in traffic and deadly accidents. Not to mention real blood lost when our built-environment fails and people lose their lives, which happened far too often in 2017 and at a record cost. If the Brookings Institute is correct, then the tax bill may serve to exacerbate efforts by cities and states to respond to this burgeoning built-environment crisis.

The Brookings Institution is a nonprofit public policy organization based in Washington, DC. Our mission is to conduct in-depth research that leads to new ideas for solving problems facing society at the local, national and global level.

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