“It’s essential to ensure escalation forecast numbers are correctly set, no matter how uncomfortable the results may be.”

High Inflation, High Stakes: The Case for Realistic Escalation in Infrastructure Budgeting

Introduction: The Cost of Low Assumptions

Public infrastructure projects are planned years in advance, and their budgets rely heavily on escalation rate forecasts – the assumed annual inflation in construction costs. For much of the past decade, these forecasts were comfortably low, often around 3% per year, reflecting a long period of modest inflation. Planners grew accustomed to using those historical averages in their budgeting models. However, recent years have upended those assumptions. Surging inflation and volatile markets have exposed the dangers of relying on historically low escalation rates. Many agencies that budgeted for 3-4% annual cost increases were blindsided when actual construction inflation hit double digits in 2021-2022. The result has been budget shortfalls, project overruns, and tough choices about which projects to scale back or delay. This article explores why using accurate – and sometimes uncomfortably high – escalation forecasts is critical for public infrastructure budgeting, especially in today’s volatile economic climate. We’ll look at real data on recent cost indices, compare different inflation scenarios (3%, 6%, 9%) to see how they impact a multi-year construction program, and discuss the risks municipalities face if they underestimate inflation (such as project deferrals or needing to go back to voters for more funding). The goal is to provide an authoritative yet accessible overview for industry professionals, contractors, and municipal planners on planning for inflation in infrastructure projects.

The Danger of Historically Low Escalation Assumptions

For many years, inflation in construction costs was relatively tame. From roughly 2010 through 2020, U.S. construction cost inflation averaged around 3% to 4% annually. These stable, low rates became the default assumption for budget forecasts. Municipal capital improvement plans and bond programs routinely plugged in a 3% escalation factor, expecting that yesterday’s prices plus a small uptick would cover tomorrow’s costs. In normal times, this approach worked – historical averages provided reasonably accurate estimates.

But the past few years have been anything but normal. Beginning in 2021, inflation spiked to levels not seen in decades, and construction prices in particular far outpaced general inflation. The years 2021 and 2022 turned out to be anomalies: in most U.S. regions, construction cost inflation exceeded 10% annually for extended periods. For example, the well-regarded Engineering News-Record index reported 12.4% annual construction inflation in Minneapolis for 2022, and many other cities saw similar double-digit surges. Contractors were hit with rapid increases in material costs – in some cases receiving new price quotes weekly – making it “especially difficult to estimate costs” during the design phase.

The consequence of these anomalies was that budget forecasts based on historical low inflation were grossly underestimating actual costs. As one report noted, if school districts (or any public owner) used the typical 3-4% inflation assumption to estimate projects in 2022, the bids would have overshot those estimates by a double-digit percentage. In other words, a project expected to cost $100 million might come in at $110–$120 million instead, simply due to higher-than-anticipated inflation. Indeed, many agencies experienced this scenario in real time – a rude awakening that exposed how “comfortable” low escalation forecasts can lead to severe budget shortfalls.

Recent Inflation and Market Volatility in Construction

What exactly happened in recent years that sent construction costs soaring? A perfect storm of factors drove inflation to historic highs. The overall U.S. inflation rate jumped sharply in 2021-2022 (peaking around 9% consumer inflation in mid-2022), but construction costs rose even faster, fueled by global supply chain disruptions, labor shortages, and spikes in key commodity prices.

Federal cost indices tell the story clearly. The Federal Highway Administration’s National Highway Construction Cost Index (NHCCI) – a broad measure of highway construction prices – saw unprecedented increases. Highway construction costs jumped about 26% in 2022 alone, the largest annual increase on record (even higher than the mid-2000s boom period). In fact, 2022’s surge eclipsed the previous all-time high of ~20% from 2005. This was not a one-off spike, either; it capped several consecutive quarters of rapid increases. By late 2023, the NHCCI index was about 69% higher than it had been at the end of 2020 – a stunning escalation in just three years.

State-level data mirrored this trend. For instance, the Texas Department of Transportation’s Highway Cost Index (HCI) climbed 27.6% between September 2021 and October 2022. During that same 13-month span, the general Consumer Price Index (CPI) was up 8.6%, meaning highway construction inflation in Texas was more than triple the overall inflation rate. This huge cost growth caught officials off guard. In Texas, project bids during 2021-2022 came in $1.9 billion higher than the budget estimates had anticipated, largely due to underestimating how much prices would climb. Even after TxDOT adjusted its cost estimates upward (“marking to market” to account for inflation), bid prices still exceeded the revised estimates in many cases, especially on large, multi-year projects. Contractors, wary of continued inflation, began bidding higher to protect themselves from future cost increases. This exemplifies a broader dynamic: once inflation takes off, it can become “embedded” in behavior, with contractors and suppliers preemptively pricing in expected cost growth – driving costs even higher.

Several key drivers contributed to this run-up in costs:

• Materials and Commodities: The price of crucial construction inputs skyrocketed. For example, oil prices (WTI crude) – which directly affect asphalt, fuels for equipment, and transportation costs – swung dramatically. From a pandemic low of around $16 per barrel in April 2020, oil rebounded to about $115 per barrel by June 2022 (a nearly 600% increase). This spike pushed asphalt prices through the roof, since asphalt is petroleum-based. The U.S. DOT noted that asphalt was the single largest contributor to the NHCCI’s increases from late 2021 through 2022. Other materials saw similar inflation: steel, cement, lumber, and plastics all experienced steep price hikes due to global supply shortages and surging demand as economies reopened. By one estimate, highway construction material costs rose over 20% from 2020 to 2022, a “dramatic escalation” that led to cost overruns on many projects. 
• Supply Chain Disruptions: Pandemic-related supply chain breakdowns created scarcity for many construction products. Factory shutdowns, shipping delays, and later the war in Ukraine (impacting global commodities like steel, aluminum, and energy) all combined to drive prices higher. Lead times for equipment and materials lengthened, and contractors often had to pay premiums to get critical items on time, further elevating project costs. 
• Labor and Market Conditions: The construction labor market tightened, pushing wages up. Post-pandemic stimulus and infrastructure funding (like the 2021 Bipartisan Infrastructure Law) increased demand for construction services just as firms were struggling to hire enough skilled workers. Additionally, a decline in the number of bidders on projects (whether from labor constraints, backlogs, or risk aversion) reduced competition. Fewer bidders can mean less pressure to keep prices low, allowing bids to come in higher. The FHWA specifically pointed out that a steady decline in average bidders per contract likely contributed to cost escalation in this period. 

The net effect of these factors was extraordinary volatility in construction pricing. Costs did not rise in a gentle, predictable curve but jolted upward unpredictably. By late 2022, some relief appeared as inflation rates moderated (oil prices, for instance, fell back from their mid-2022 highs, and by early 2025 WTI was hovering around the $60–$70 range). However, volatility remains a concern – crude oil started creeping up again in early 2024, and global economic uncertainties persist. For planners, this volatility makes forecasting especially challenging. Relying on the old “stable 3%” paradigm in such an environment is a recipe for mismatch between budgets and reality.

The core lesson: When inflation runs hot, it can dramatically erode the purchasing power of infrastructure dollars. One stark analysis by the U.S. Department of Transportation showed that if the high inflation experienced in 2021–2022 were to continue, the federal government’s landmark infrastructure funding would build far less than intended. Specifically, out of about $379 billion allotted for highways in the 2021 infrastructure law, only $224 billion worth of projects could actually be delivered under a sustained high-inflation scenario – roughly 60% of the originally planned output (a 40% reduction in real project volume). Even under a more moderate inflation scenario, the buying power of that funding would drop by nearly one-third. This federal-level outlook underscores the stakes: without accurate escalation forecasts, funding levels that looked generous on paper can shrink dramatically in real terms.

How Inflation Assumptions Impact Multi-Year Budgets

Because infrastructure projects often span many years from planning to completion, compounding inflation can significantly change total costs over time. A difference of a few percentage points in the annual escalation rate, when compounded over a multi-year program, can make or break a budget. Let’s illustrate this with a hypothetical $100 million bond program rolled out over five years.

Suppose a city or county secures $100 million today to fund a package of projects (roads, water systems, buildings, etc.) that will be designed and constructed over the next five years. When setting the budget, officials must assume some annual cost escalation to account for rising prices each year. Many might be inclined to assume 3% per year, a figure reminiscent of long-term averages. But what if actual inflation turns out higher – say 6% or 9% per year? The difference in outcomes is dramatic.

Even a seemingly small increase in the assumed escalation rate has a compounding effect. If costs grow at 3% annually, a project expected to cost $100 million today would cost about $116 million after five years. At 6% annual inflation, that same scope would cost roughly $134 million in five years. And at 9% per year, it would balloon to about $154 million by year five. In other words, a $100 million budget would fall tens of millions of dollars short of delivering the originally planned projects if actual inflation runs high. The 9% scenario yields about a 34% higher cost than the 3% scenario after five years – a difference of nearly $39 million. This gap represents projects that might not get built without additional funding. It vividly demonstrates how underestimating inflation can undermine a multi-year capital program.

In practical terms, if officials assumed 3% escalation but reality followed the 9% path, they might only accomplish roughly two-thirds of the intended construction before the money runs out. They would either need to trim the program’s scope (e.g. defer or cancel some projects) or find extra funds to cover the shortfall. Neither option is attractive, which is why accurate forecasting up front is so crucial.

Risks to Municipalities of Underestimating Inflation

Underestimating inflation isn’t just a budgeting error in a spreadsheet – it has real consequences for public agencies and the communities they serve. When a city, county, or state bases its infrastructure plan on too-low escalation assumptions, it can lead to a cascade of problems:

• Project Deferrals and Scope Reductions: If costs come in higher than expected, officials often must delay projects or scale back plans to stay within the fixed budget. A 2024 analysis noted that the rapid cost increases forced many project managers to either reduce the scope of projects or delay them altogether. In the context of the federal infrastructure law, rising costs mean potentially fewer miles of highway repaved, fewer bridges fixed, and generally less infrastructure delivered than promised. At the local level, this might mean a city can only afford, say, 7 new school renovations instead of the 10 originally approved, or a county must postpone a much-needed road expansion by several years. Deferring projects has a knock-on effect: not only do citizens wait longer for improvements, but construction inflation can continue to compound during the delay, making the eventual project even more expensive. 
• Budget Overruns and Funding Gaps: Some agencies attempt to press ahead with all projects despite higher prices, only to discover a funding gap. Capital programs that go over budget due to underestimating inflation may scramble to find additional money – drawing from reserve funds, cutting into operational budgets, or seeking state/federal assistance. In one state transportation program, officials initially covered inflation-driven overruns using contingency reserves, but acknowledged that reserves won’t last forever and that planned projects will be put on hold if costs continue to outstrip available funds. This scenario is playing out in various jurisdictions: inflation is eating away at infrastructure dollars, and without adjustments, some projects simply cannot proceed. 
• Returning to Voters or Borrowing More: For projects funded by voter-approved bonds or tax measures, a particularly painful outcome of underestimating costs is having to return to the voters to ask for more money. Imagine telling taxpayers that the bond they approved isn’t enough to finish the job because inflation was higher than expected. Such a “supplemental” bond request or tax increase is not only politically difficult – it can undermine public trust. Most municipalities view this as a last resort. Nonetheless, it becomes a possibility if, for example, a school district promised a slate of new schools for $500 million but then finds out it really needs $600 million due to inflation. Alternatively, agencies might resort to taking on additional debt or reallocating funds from other programs to cover the gap, which can strain future budgets. 
• Contractor and Public Perception Issues: When budgets prove insufficient, it can create an impression of poor planning. Contractors may become wary of bidding on public projects if they fear funding shortfalls will lead to cancellations. The public might grow skeptical of infrastructure initiatives if promised projects don’t materialize on schedule. These less tangible risks reinforce why getting the estimates right is important for credibility and smooth implementation. 

In summary, underestimating inflation transfers risk to the public sector. Either projects don’t get delivered as planned, or agencies must scramble to fill the gap – often at higher expense and with delays. As one commentary put it, if construction prices stay high, we’ll see “projects being delayed or placed on indefinite hold as available funding can no longer cover the cost of planned projects”. No municipality wants to be in that position, which is why prudent forecasting is a top priority.

Embracing Realistic Forecasts and Building Resilience in Budgets

Faced with these challenges, what can public agencies do? The clear answer is that budgeting practices must adapt to the new inflation reality. This means embracing more realistic – even if initially uncomfortable – escalation rate forecasts, and building more resilience into project plans. Some key strategies include:

• Use Current Data and Indices: Planners should closely follow up-to-date construction cost indices (such as the FHWA’s NHCCI, state DOT indices like TxDOT’s HCI, and industry indexes from ENR or others) and base forecasts on recent trends, not just long-term historical averages. If the data shows costs rising 8% annually of late, it is prudent to budget in that range rather than assume a reversion to 3% immediately. Cost indices and commodity trends (e.g. steel, cement, oil prices) can provide early warning of inflationary surges. By tracking these, agencies can update their estimates in real time. In today’s market, stale assumptions can be dangerous, so a shift to dynamic forecasting – regularly revising escalation rates as new data comes in – is essential. 
• Scenario Planning: Rather than banking on a single number, many agencies are now employing scenario analysis. This means budgeting for multiple inflation scenarios – for example, a low case (perhaps 4%), a moderate case (6%), and a high case (8-10%). By examining how a project or program would fare under each scenario, officials can gauge the potential range of outcomes. They might adopt the moderate-to-high scenario for initial budgeting to be safe, or at least have contingency plans for the high-inflation case. Scenario planning makes the uncertainty explicit. It can also help communicate to stakeholders (e.g. elected officials or the public) why a higher budget estimate is being used – it’s not padding for vanity, it’s protecting the program against realistic inflation possibilities. 
• Higher Contingencies and Escalation Allowances: One straightforward way to build resilience is to include larger contingencies or dedicated inflation allowances in project budgets. In the past, a 10% contingency might have sufficed; now, it may be wise to earmark a higher percentage of the project cost for inflationary growth. Some agencies have created separate line items for “construction inflation reserve.” This money can only be used to offset cost increases due to market conditions. If it isn’t needed, great – it can be reallocated or returned. But if prices surge, the reserve can keep projects on track without immediately going back for more funding. 
• Phasing and Flexibility: When possible, structuring projects in phases or with alternates can provide flexibility to adjust if inflation erodes buying power. For instance, a road expansion could be bid with a base segment and optional add-on segments. If bids come in high, the agency might award the base only, and defer the add-ons until later or until more funds are available. This ensures at least part of the project gets done within budget. Designing projects with some modularity or prioritization of components can make it easier to scale back scope if needed without entirely derailing the core objectives. 
• Value Engineering and Cost Management: In an environment of high inflation, rigorous cost management is critical. This includes value engineering (finding more cost-effective ways to achieve the project’s goals, such as using alternative materials or designs) and timing strategies (for example, ordering certain materials early if prices are expected to rise further, or negotiating longer-term price locks with suppliers). While these practices are standard in large projects, they take on heightened importance when every month can bring 1%+ increases in costs. Additionally, some agencies are exploring contract provisions to share inflation risk (such as price adjustment clauses for materials) so that contractors don’t add huge risk premiums to their bids – though this must be balanced carefully. 

Ultimately, facing the truth about inflation upfront is far better than denial. It might be politically uncomfortable to present a higher cost estimate for a new infrastructure bond or capital plan – for instance, telling voters that a project might need a 6% yearly escalation instead of the “usual” 3%. Higher estimates can raise eyebrows and invite scrutiny. But transparency about inflation pressures, backed by data, can also build credibility. As the turmoil of the past few years has shown, the cost of wishful thinking can be far worse: projects left incomplete, public commitments unfulfilled, and emergency financial fixes that strain taxpayers even more.

Industry experts echo this sentiment. They advise planners to “use higher inflation percentages in forecasting” and adjust project plans to accommodate market conditions. By incorporating realistic escalation rates (even if that means 5%, 6%, 7% or more), public agencies can better ensure that the funds they ask for will truly deliver the promised outcomes. In short, robust forecasting and strategic planning are now integral parts of infrastructure delivery in a high-inflation era.

Conclusion: Planning for Volatility

The experience of the recent inflation spike has reinforced a fundamental lesson for infrastructure budgeting: you ignore escalation at your peril. In times of market volatility, the “status quo” inflation assumption is a liability. It may be tempting to use a low figure to keep projected costs down on paper, but reality has a way of upending those rosy projections. The more responsible approach – and ultimately, the more fiscally sound one – is to budget with eyes wide open. This means accounting for the possibility of uncomfortable inflation rates and being prepared to manage their impact.

The good news is that inflation will not always be as high as it was in 2022; indeed, there are signs that construction cost increases have moderated from their peak. But moderating is not the same as disappearing. Even at, say, 5% annual cost growth (half the rate of 2022’s spike), a long-term program could see significant erosion of purchasing power if not planned for. Public agencies now have the knowledge (hard-earned from recent experience) and tools – from detailed cost indices to smarter forecasting techniques – to plan better. By leveraging these tools and adopting a mindset of caution and adaptability, industry professionals, general contractors, and municipal planners can safeguard their projects against inflation’s risks.

In summary, using accurate and even discomfortingly high escalation forecasts is not about pessimism; it’s about realism and resilience. Budgeting realistically for inflation protects infrastructure programs from future funding crises, ensures that critical projects are delivered as promised, and upholds the trust of the public. In an inflationary environment, a good budget is one that is ready for bad news. By expecting the unexpected in cost escalations, we can keep our infrastructure plans on solid ground – no matter how the economic winds may shift in the years ahead.

Front Line Advisory Group (FLAG) is a Program Management Consulting (PMC) firm focused on delivering bond-funded infrastructure projects on time and on budget through disciplined management and data-driven controls. Our mission extends beyond consultation – we empower our clients to realize the full potential of their investments, ensuring tax dollars are put to maximum use through astute Program Management Consulting. For more information or to commence your journey towards transformative bond management, reach out to us at Info FLAG