December 7, 2011
Infrastructure and Transportation
Federal Loan Guarantees for the Construction of Nuclear Power Plants
August 3, 2011
CBO's analysis examines the main factors that influence the cost to the federal government of providing loan guarantees for the construction of nuclear power plants. It includes illustrative cost estimates using the methodology specified by the Federal Credit Reform Act of 1990, which determines the budgetary cost of the program, and also estimates prepared on a fair-value basis, which provide a more comprehensive measure of cost. CBO found that the expected cost to the federal government of guaranteeing a nuclear construction loan varies greatly depending on a project's characteristics. Budgetary estimates of guarantee costs are significantly lower than the corresponding fair-value estimates. However, because of the high degree of uncertainty involved, it may not be possible to charge borrowers the full cost of a loan guarantee, either under credit reform or on a fair-value basis.
Among the goals often posited for federal energy policy are to enhance energy security by diminishing the nation's reliance on foreign oil, to meet a growing demand for electricity, and to reduce greenhouse gas emissions by encouraging investment in clean energy production and technologies. To help further such objectives, the Energy Policy Act of 2005 (Public Law 109-58) established incentives to encourage private investment in innovative technologies, including advanced nuclear energy facilities. Much of the support for such investment is provided under title XVII of that legislation, which offers federal loan guarantees for the construction of nuclear power plants and other types of "alternative" energy facilities.
Administered by the Department of Energy (DOE), the loan guarantee program encourages private investment in nuclear energy by lowering the cost of borrowing and possibly increasing the availability of credit for project sponsors—usually an individual utility, a consortium of utilities, or a merchant power producer. In exchange for providing a loan guarantee, DOE is authorized to charge sponsors a fee that is meant to recover the guarantee's estimated budgetary cost.
However, budgetary cost estimates—which are calculated as required under the Federal Credit Reform Act of 1990 (FCRA)—are not a comprehensive measure of the cost to taxpayers of those guarantee commitments. Specifically, FCRA estimates do not recognize that the government's assumption of financial risk has costs for taxpayers that exceed the average amount of losses that would be expected from defaults; those additional costs arise because a borrower is most likely to default on a loan and fail to make the promised payments of principal and interest during times of economic stress, when the losses are especially painful for taxpayers. Consequently, the estimated budgetary cost of a guarantee is generally lower than its estimated "fair-value" cost, which approximates the market price that a private guarantor would charge for an obligation with similar risk and expected returns.
Because budgetary cost estimates are not a comprehensive measure of the taxpayer resources committed, and because of concerns about the accuracy of the methods and assumptions that DOE uses to forecast default rates and recovery values, some commentators have suggested that federal loan guarantees for the construction of nuclear power plants are being systematically underpriced, whereas others believe they are being overpriced.
For this study, the Congressional Budget Office (CBO) reviewed the many factors that can influence the cost to the government of guaranteeing loans for the construction of advanced nuclear facilities; developed a model to estimate guarantee costs for a representative loan using both FCRA-based and fair-value methodologies; performed a sensitivity analysis of those estimated costs to changes in assumptions about key drivers of cost; and explored the challenges inherent in attempting to charge borrowers the full cost of a loan guarantee. CBO's findings are as follows:
- The expected cost to the federal government of guaranteeing a nuclear construction loan will vary greatly depending on a project's characteristics and on the economic and regulatory environment in which the project will operate. Important considerations include capital structure (the mix of debt and equity used to finance the project); ownership structure (whether it is a stand-alone project or part of a diversified company); whether construction costs may be passed on to utility ratepayers or local taxpayers; the regulatory environment; the degree of uncertainty about construction costs; the cost of competing generation technologies; and the demand for electricity. Although a serious nuclear accident could entail extremely large costs to investors and society, that risk has a small effect on the direct cost to the government of providing a guarantee because liability under the guarantee is limited to the amount of the debt, and the probability that such an accident will occur is low.
- Default rates and recovery rates are likely to vary considerably, both across projects and over the lifetime of a given project. CBO does not have enough information to independently estimate an average recovery rate for nuclear construction loans. However, assigning a similar expected recovery rate as a starting point for all projects—which is DOE's current practice—does not appear to make full use of the information available to DOE through its detailed project assessment process. For example, when sponsors of stand-alone projects cannot pass on construction costs to rate-payers, very low recoveries may result if bankruptcy occurs during the construction phase. By contrast, recovery rates may be considerably higher once projects become operational.
Using a single recovery rate tends to increase the variability of estimated guarantee costs relative to their true values, which increases the government's exposure to a phenomenon known as adverse selection. Adverse selection occurs when borrowers are better able than the government to assess the value of a guarantee offer and take advantage of their superior information at the government's expense. For nuclear construction loans, borrowers will tend to turn down a guarantee if they believe the fee set by DOE is too high but go forward if they consider it fair or underpriced, which increases the likelihood that DOE's portfolio will include more projects for which the subsidy fee has been underestimated than overestimated.
- When credit ratings are used to assess default probabilities, cost estimates will vary widely with the assigned ratings category, the assumed recovery rate, and whether Treasury interest rates or estimated market interest rates are used for discounting. CBO relied on the information in historical credit ratings to impute default probabilities (as does DOE) and considered a range of recovery rates that might apply to different projects depending on their characteristics. As required under FCRA, budgetary estimates use Treasury interest rates for discounting future cash flows; fair-value estimates rely on estimates of the applicable market interest rates for discounting.
- Budgetary estimates of guarantee costs are significantly lower than the corresponding fair-value estimates, which provide a more comprehensive measure of the cost to taxpayers. CBO used the credit rating associated with a project to derive the discount rate the market would most likely assign to the loan cash flows. For example, if the risks associated with a guaranteed loan are in the range of those posed by bonds rated A (less risky) and bonds rated BB (riskier), and if 55 percent of the amount owed is expected to be recovered in the event of a default, the budgetary cost, measured on a FCRA basis, ranges from 1 percent to 6 percent of the principal loaned. In contrast, the fair value of the guarantee ranges from 9 percent to 21 percent of the principal loaned.
- Because of the high degree of uncertainty involved, it may not be possible to charge borrowers the full cost of a loan guarantee. When adverse selection is severe, attempts to offset expected losses with an increase in fees can backfire because the higher fees drive away creditworthy borrowers, making it impossible to provide a loan guarantee that does not involve a subsidy.
CBO relied on a credit-ratings-based approach to evaluate the probability of default rather than on the historical experience of the nuclear industry, for which not enough data exist to draw quantitative inferences. However, historical experience suggests that investing in nuclear generating capacity engenders considerable risk. One study found that of the 117 privately owned plants in the United States that were started in the 1960s and 1970s and for which data were available, 48 were canceled, and almost all of them experienced significant cost overruns. As a consequence, most of the utilities that undertook nuclear projects suffered ratings downgrades—sometimes several downgrades—during the construction phase.
However, bondholders experienced losses from defaults in only a few instances. Losses for the most part were borne by the projects' equity holders, the regions' electricity ratepayers, and the government. Supporters of nuclear power argue that newer plant designs and changes in the regulatory environment make nuclear investments less risky now, but recent experience abroad suggests that cost overruns and delays are still common phenomena, and concerns remain about an uncertain regulatory environment and changes in demand for electricity.
Finally, although the federal budget is intended to account for the costs of federal activities, it does not account for the benefits of such activities. As is the case with other types of federal spending, loan guarantees for the construction of nuclear plants might increase well-being by supporting activities that are valuable to society but that are unlikely to be economically viable without governmental support. In assessing the value of the program, such benefits must be weighed against the costs of those activities. However, an analysis of the benefits of loan guarantees for nuclear construction is beyond the scope of this study.
- October 17, 2012
Alternative Approaches to Funding Highways
March 23, 2011
About 25 percent of the nation's highways, which carry about 85 percent of all road traffic, are paid for in part by the federal government. Federal spending on highways comes primarily from taxes on gasoline and diesel fuel, but those and other taxes paid by highway users do not yield enough revenue to support current or proposed federal spending on highways. Although raising fuel taxes would increase revenue, those taxes alone cannot provide a strong incentive for highway users to consider all of the costs their road use imposes on others. This CBO study, prepared at the request of the Senate Budget Committee, examines broad alternatives for federal funding of highways, focusing on fuel taxes and on other taxes that could be assessed on the basis of the number of miles that vehicles travel.
About 25 percent of the nation's highways, which carry about 85 percent of all road traffic, are paid for in part by the federal government; the remaining funding for highways comes from state and local governments. Federal spending on highways is funded primarily by taxes on gasoline and diesel fuel, but those and other taxes paid by highway users do not yield enough revenue to support either current federal spending on highways or the higher levels of spending that have been proposed by some observers. Although raising those taxes would bring in a larger amount of revenue, a more fundamental issue would remain: By themselves, fuel taxes cannot provide a strong incentive for people to avoid overusing highways-that is, to forgo trips for which the costs to themselves and others exceed the benefits. This study examines broad alternatives for federal funding of highways, focusing on fuel taxes and on taxes that could be assessed on the basis of the number of miles that vehicles travel.
Approaches to funding highways can be evaluated in terms of equity and economic efficiency. Equity, or fairness, is subjective and can be assessed in several ways. Observers of highway funding often gauge fairness by considering the share of funding that is obtained from taxes paid by highway users rather than from general taxpayer funds, from people in households that fall into various income categories, or from people in rural versus urban households.
The economic efficiency of a funding approach depends partly on its effects on users' travel behavior and partly on what it costs to implement. Charging users for the costs their travel imposes on society would create incentives for people to limit highway use to trips for which the benefits exceed the costs, thus reducing or eliminating overuse of highways and helping identify the economic value of investments in highways. However, the costs of collecting and enforcing such user charges also must be considered in evaluating their net effect on efficiency.
Charging for the Costs of Highway Use
The cost of users' travel is different from the cost of -highway construction and maintenance, although those costs overlap. Some construction and maintenance costs are tied to use. For example, the cost of some maintenance depends on the extent of pavement damage caused by heavy vehicles. In contrast, other maintenance costs-such as those to repair damage caused by aging and weathering-are fixed and would accrue regardless of how much a road is used.
Any given driver's highway use also imposes costs on other users, on nearby nonusers, on the environment, and on the economy in the form of congestion, risk of accidents, noise, emissions of greenhouse gases and pollutants that affect local air quality, and dependence on foreign oil.
Different types of vehicles traveling in different locations contribute differently to the social costs of highway use. Passenger vehicles log more than 90 percent of all miles traveled on U.S. highways, and they are responsible for the largest share of the total costs of highway travel. In particular, urban travel by passenger vehicles constitutes about two-thirds of all vehicle-miles traveled, and it is the primary source of congestion, the largest category of social costs. Heavy trucks travel less than 10 percent of all vehicle miles, but their costs per mile are far higher than are those for passenger vehicles, and they are responsible for most pavement damage.
Estimates from several sources indicate that most highway users currently pay much less than the full cost of their travel. Given current fuel efficiency, federal and state fuel taxes combined produce revenue of roughly 2 cents per mile for automobiles. In contrast, the Federal Highway Administration estimates that the national average cost for congestion caused by automobile travel is about 10 cents per mile-much higher in large metropolitan areas and much lower in rural communities. Total costs, including those for accident risk and noise, are higher still.
Judging from estimates of the costs of highway use, a system that charged for all such costs would have most if not all motorists paying substantially more than they do now-perhaps several times more. Such a system would maximize the efficiency of highway use by discouraging trips for which costs exceed benefits. Alternatively, taxes that were set below the full costs of use but were structured to reflect those costs more closely than current taxes do could yield a portion of the efficiency gains by discouraging some high-cost trips.
Most of the costs of using a highway, including pavement damage, congestion, accidents, and noise, are tied more closely to the number of miles traveled than to the amount of fuel consumed. (Because of the way passenger vehicles are regulated, their emissions of local air pollutants, such as particulate matter and sulfur dioxide, also are more closely related to miles traveled. The cost of local air pollution from trucks, which is regulated differently, is fuel related.) Fuel consumption depends not only on the number of miles traveled but also on fuel efficiency, which can differ from one vehicle to another and can change with driving conditions; therefore, charging highway users for the full costs of their use, or in proportion to the full costs, could not be accomplished solely through fuel taxes. Accomplishing those goals would require a combination of fuel taxes and per-mile charges, sometimes called vehicle-miles traveled (VMT) taxes.
Viewed according to different conceptions of equity, fuel taxes offer a mix of positive and negative characteristics. They satisfy a "user-pays" criterion, but they also can impose a larger burden, relative to income, on people who live in low-income or rural households. Even for households that do not own passenger vehicles, the taxes impose an indirect burden because they raise the transportation costs that are reflected in the prices of purchased goods.
Fuel taxes have two desirable characteristics for efficiency: They cost relatively little to implement (the government collects taxes from fuel distributors, and users pay the taxes when they purchase fuel), and they offer users some incentive to curtail fuel use, thus reducing some of the social costs of travel. At best, however, the strength of that incentive can be right only as a rough average, discouraging some travel too much and other travel too little, because it does not reflect the large differences in cost for use of crowded roads compared with uncrowded roads or for travel by trucks that have similar fuel efficiency but cause different amounts of pavement damage. Moreover, for a given tax rate on fuels, the incentive to reduce mileage-related costs diminishes over time as more driving is done in fuel-efficient vehicles.
Potential Taxes on Vehicle-Miles Traveled
VMT taxes are qualitatively similar to fuel taxes in their implications for equity. Like fuel taxes, they satisfy the user-pays principle, but they impose larger burdens relative to income on people in low-income or rural households. However, to the extent that members of such households tend to drive vehicles that are less fuel efficient, such as pickup trucks or older automobiles, those highway users would pay a smaller share of VMT taxes than of fuel taxes.
VMT taxes that are aligned with the costs imposed by users would provide a better incentive for efficient highway use than fuel taxes do because the majority of those costs are related to miles driven. However, VMT taxes' effect on overall efficiency also would depend on how much it costs to put the taxes in place and to collect the money. Estimates of what it would cost to establish and operate a nationwide program are rough. One source of uncertainty is the cost to install metering equipment in all of the nation's cars and trucks. Having the devices installed as original equipment under a mandate to vehicle manufacturers would be relatively inexpensive but could lead to a long transition; requiring vehicles to be retrofitted with the devices could be faster but much more costly, and the equipment could be more susceptible to tampering than factory-installed equipment might be. Despite the various uncertainties and impediments, some transportation experts have identified VMT taxes as a preferred option.
One step in developing per-mile charges would be to determine the goals of VMT taxation; different goals would require different charges. For example, if VMT taxes were intended to maximize the efficiency of highway use, they would need to vary greatly by vehicle type and by time and place of travel. Pavement damage increases sharply with vehicle weight but decreases with the number of axles on a vehicle, so the portion of VMT taxes assessed to maintain pavement would need to be small or nonexistent for passenger vehicles but substantial for heavy-duty trucks, particularly those with high weight per axle. Similarly, every vehicle would be assessed more to travel on crowded urban roads during peak hours than in off-peak hours or to travel on less congested roads at any time. The rates charged for peak-hour travel would be set in keeping with specific local or regional conditions, including the duration and severity of daily congestion, rather than on the basis of national averages. If the VMT taxes were intended to achieve some other goal, the structure of the taxes might be different.
The idea of imposing VMT taxes that vary by time and place has raised concerns about privacy because the process of assessing such taxes could give the government access to specific information about how individual vehicles are used. Various approaches have been suggested to allay those concerns, including restricting the amount of information about a vehicle's travel that is used in billing or restricting the kind of information that is conveyed to the government; making devices appealing to the public by allowing businesses to use them to provide other services, such as real-time traffic reports or electronic payment for parking; and allowing users to opt out of paying per-mile charges and instead pay higher fuel taxes. (The optional fuel taxes would be set at rates high enough to appeal only to users with the greatest privacy concerns.)
A system of VMT taxes need not apply to all vehicles on every road. Indeed, there are already less comprehensive systems of direct charges for road use: Toll roads, lanes, and bridges are common in the United States, and several states and foreign countries levy weight-and-distance charges on trucks. Expansion of existing systems could focus on highly congested roads or on entry points into congested areas; that targeted approach could cost less to implement if it required relatively simple in-vehicle equipment. (The E-ZPass transponder is one example. E ZPass is an electronic collection system that allows prepayment of tolls in 14 states, from Maine in the northeast, to Virginia in the south, to Illinois in the west.) Alternatively, the focus could be on specific vehicle types, such as trucks. Although less than 4 percent of the nation's fleet is made up of trucks (excluding light-duty trucks), they account for roughly 25 percent of all costs highway users impose on others, including almost all of the costs associated with pavement damage.
Spending and Funding for Highways
January 20, 2011
The nation's network of highways plays a vital role in the U.S. economy; private commercial activity and people's daily lives depend on that transportation infrastructure. In 2007, the public sector spent $146 billion to build, operate, and maintain highways in the United States. About three-quarters of that total was provided by state and local governments. One-quarter was provided by the federal government, primarily through the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU). The initial authorization for that law has expired; as the Congress considers the future role of the federal government in providing highway infrastructure, it faces three important questions: how to structure decisionmaking about highway projects, how much money to spend on highways, and how to pay for that spending.