It is no secret that state and local governments face a number of challenges that may constrain their ability to issue debt to finance the myriad of infrastructure projects that are becoming increasingly difficult to ignore.

Traditional, tax-backed resources are drying up due to the combination of pressures that prevent officials from following the usual routes to raise capital. The continuing shift of spending responsibilities from Washington to states and localities, a sharp slowdown in economic growth, increasing public investment needs, and widespread voter resistance to tax increases have hampered the ability to issue bonds.

This trend is evidenced by the ongoing move away from property taxes and toward user-based revenues as the source of debt repayment. In 1975, only one-third of all new municipal bond issues were backed by user revenues. By 1990, that number had grown to 68%.

The commission should consider a number of initiatives that would facilitate financing transportation infrastructure needs.

Consider initiatives that directly benefit state and local governments. One proposal is to relax the arbitrage rebate restrictions relating to bonds issued to finance, but not refinance, infrastructure projects.

The purpose of this change would be to increase arbitrage earnings that would be used to fund project costs, in particular preconstruction planning and research and development costs incurred at the outset of a project. The Internal Revenue Code could be amended to permit an extended construction period during which net investment earnings could be retained for investment in the project.

If the federal government is committed to easing the crucial bottleneck in infrastructure - financing the early stages of a project, the funding for which is often unavailable - a rewrite of appropriate sections of the code may well be a cost-effective method of providing some relief.

Of course this change has a cost, but lower rates and reduced borrowing costs for those involved in the transaction provide a positive benefit. More infrastructure projects could well increase U.S. productivity.

Careful definitions of the types of projects for which such bonds could be issued would limit opportunities for abuse.

Another change in the Internal Revenue Code would attract a segment of the investment community willing to accept greater risk for higher return, a logical source of additional investment.

If the code were altered to exclude the interest paid on bonds issued to provide financing, but not refinancing, of infrastructure products from both the individual and corporate alternative minimum tax, investors would have a greater incentive to invest in the infrastructure bonds.

A second possibility, designed to provide a better yield in return for greater risk, is to permit the amount lost by an investor due to a default on a bond issued to finance, but not refinance, an infrastructure project to be offset wholly against the investor's ordinary income.

These two suggestions are not a panacea. Private corporate investment will never totally replace the need for government funding for projects that do not have demonstrated creditworthiness.

For those infrastructure projects that are not self-supporting, the government could establish a grant or loan program for direct investment. Such a program could be structured as a short-term facility - perhaps five years - for projects that need assistance in the start-up phase.

The government's grant or loan could be repaid by selling securities supported by the project or pools of projects with proven track records. Alternatively, a revolving fund capitalized in part with federal dollars, similar to the Environmental Protection Agency's wastewater revolving fund concept, should also be considered.

Another possibility that has been discussed is the creation of government-sponsored enterprises to finance projects that do not have enough demonstrated ability to service the debt issued to attract private sources of capital.

Existing enterprises of this sort have become centers of controversy for several reasons, including their implied backing by the federal government, their lower capital costs and resulting superior trading value in areas serviced by private enterprise. This head-to-head competition always finds the government-sponsored enterprises on top and discourages private-sector involvement.

We are opposed to the creation of a government-sponsored enterprise that could compete against the private sector. However, with appropriate limitations and oversight by parties dedicated to keeping the new entity out of the areas serviced by private enterprise, it may be possible to create a government-sponsored enterprise that would remain firmly committed to its limited mandated role.

Quite simply, the key to solving America's infrastructure crisis is to further involve, not discourage, the private sector.

Stern is president and chief executive officer of Financial Guaranty Insurance Co.

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