Q&A: A Harris Municipal Finance Expert Discusses President Biden's "Rescue Plan"

Throughout the pandemic, Research Professor Justin Marlowe watched as revenue shortfalls caused a corresponding drop in core services delivered by state and local governments. Greater economic activity coupled with federal legislation – some already passed and others pending – promises to begin to further refill those coffers, but much remains unknown. And Marlowe is all too aware of the crucial connection between people’s lives and livelihoods and the health of these often already strained municipal budgets

An expert on public finance, with emphasis on public capital markets, infrastructure finance, state and local budgeting, and financial disclosure, Marlowe joined Harris Public Policy and its Center for Municipal Finance at the start of the 2021 academic year. He also currently serves as Editor-in-Chief of Public Budgeting & Finance.

With the recent enactment of the American Recovery Plan – and the American Jobs Act and American Family Plan taking shape – we sat down with Professor Marlowe to talk about the municipal finance landscape and more.

Let’s start with the American Recovery Plan. Much attention was paid to its unemployment benefits and stimulus payments to a majority of Americans, but it had several other vital provisions. How did it affect municipalities?

The American Rescue Act of 2021 included more than $300 billion in financial support for states and localities. That support allowed them to stave off additional cuts to spending on core services, and to expand support for local businesses, public health capacity, job training programs, and other spending that makes a huge difference in people’s lives. In short, it stabilized municipal finance and set the stage for the post-pandemic economic recovery. The municipal finance components of the American Rescue Plan will have been a major contributing factor to a successful recovery, although that fact will be largely unappreciated by the general public.

Beyond the American Rescue Plan, what else are municipal finance experts and those government administrators hoping to see from the Biden administration? 

Municipal finance experts are carefully watching the Biden infrastructure plan. That plan has sparked considerable debate because it redefines "infrastructure." That word traditionally meant long-term investments in roads, bridges, sewers, and other tangible assets designed to facilitate local economic development. The Biden plan expands that definition to include spending that bolsters the contemporary social safety net, like $400 billion for home health care and $213 billion for affordable housing.

What’s at the heart of this debate?

Proponents of the plan argue these new types of infrastructure investment offer a better return on investment than traditional infrastructure because they expand economic opportunities. Critics say this redefinition is nothing more than a massive expansion of routine spending on social programs, packaged as an infrastructure investment, that will deliver little if any long-term return on investment. That's a fair criticism. What’s less controversial is how the President has proposed to pay for it: by collecting more income taxes from top earners, mostly through an increase in statutory tax rates, better enforcement of tax law, and curbing abuse of certain tax preferences.

Will that approach to raising revenue be enough?

It’s unclear whether targeting top earners alone will generate enough revenue to pay for the entire plan, but this represents a reasonable first step. This is in sharp contrast to previous infrastructure plans that have proposed to increase the federal gas tax, a move that is both inefficient and distortionary from a municipal finance perspective, and politically unpopular.

Even more sensible is how the President has telegraphed his strategy to move the plan through Congress. He's made his priorities clear, invited counterproposals, and put the debate on a reasonable but limited timeframe. "Infrastructure Week" has been a punchline in Washington for years, mostly because past presidents have been unable to manage the complex legislative maneuvering and negotiation required to move such a massive piece of legislation. It's clear that the Biden team does not intend to make those same mistakes.

What would the infrastructure plan’s impact have on the bond market?

An often-overlooked point is that the infrastructure plan might eventually include several statutory and other technical components that that would have a major effect on the municipal bond market. Muni market participants have said for years that an infrastructure plan is far more likely to succeed if states and localities have access to some of the financing tools that were taken away as a result of the 2017 tax bill. Those tools include advanced refundings, tax credit bonds, expanded eligibility for bank qualified issuance, and others. It will be interesting to see if those proposals are included in the final infrastructure plan.

Besides the parts of the legislative packages that seems to get all the headlines, what else is happening?

Within the past two week or so we've seen lots of attention on two other proposals with major implications for municipal finance. One is a push by the Democrats to lift the cap on the state and local tax (SALT) deduction. Those caps were enacted as part of the 2017 tax bill. They limit how much property tax and other local taxes property owners can deduct from their federal income taxes, in effect increasing their federal tax bill. Not surprisingly, that cap was wildly unpopular in areas with comparatively high local property taxes (like Illinois!). Republicans have signaled some willingness to consider lifting that cap as part of the negotiations surrounding the infrastructure plan. The other big proposal is the President's plan for universal pre-K and community college. That would require massive capital investments to build the classrooms, labs, and other infrastructure needed to support a major increase in enrollments. 

Will do you make of Republican counter proposals? What in your estimation would the optimal infrastructure legislation look like?

The federal government’s role in “public infrastructure” has expanded many times since our founding. The original Constitutional Convention happened in part because George Washington proposed a series of interstate canal projects that critics called a massive overreach of federal authority. Lincoln used the federal government’s land authority to clear a path for the transcontinental railroad. FDR’s New Deal programs were sold to the public as a bridge to the new 20th century economy. The federal interstate highway system, barely 75 years old, replaced a centuries-old network of state and local highways. Proponents of President Biden’s infrastructure plan say that digital broadband, clean energy, home health care, and affordable housing are the canals, railroads, Social Security, and highways of the 21st Century economy. According to that logic, it’s entirely appropriate for the federal government to once again expand its definition of public infrastructure and take on a larger role in providing it.

Republicans – and a few center/center-left Democrats – say the federal government should not take on new infrastructure without first maintaining its current infrastructure. There are trillions of dollars in unfunded maintenance on federal highways alone. Much of that backlog is due to the lack of a reliable funding source. It’s also a drag on productivity and grows exponentially larger as infrastructure systems deteriorate to the point that they require replacement. Many on the right would not oppose raising income taxes on the wealthy and on corporations to fund infrastructure improvements, so long as we first invest in our existing infrastructure.

The optimal proposal, in my view, is a two-step plan. First, a large federal infrastructure plan focused on maintenance and re-building existing infrastructure that includes a reliable long-term funding mechanism and the tools to help states and localities implement that plan. Second, and immediately thereafter, a plan to invest in broadband, clean energy, and other “21st Century” infrastructure through reductions in other federal spending, public-private partnerships, and perhaps new federal taxes.