Journalists who cover government and public affairs have been hearing a great deal about how privately financed and operated toll roads may be the best solution to the nation’s chronic under-investment in its highway system. Here are some background facts on “privatization” and questions that journalists should ask when they do stories about private toll-road proposals.
The Investment Problem
In recent decades, the United States has been investing too little in the roads and bridges of its highway network. Right now, we should be spending at least $20 billion more per year simply to keep these essential transportation facilities from deteriorating any further. To fund the upgrading, modernization and expansion needed to support a growing economy would require a $40 billion per year increase in what we’re currently spending.
A key reason for this lack of adequate investment is the magical transformation of what were once called “dedicated transportation user charges” (such as motor vehicle fuel taxes) into sources of general tax revenue. The federal government has been reducing its budget deficit by holding down infrastructure outlays from the Highway Trust Fund so that the resulting surpluses of annual user charge revenues can be used to help cover non-transportation expenses. Many state governments are doing the same thing.
Meanwhile, the world’s financial markets are awash with private capital looking for economically sound infrastructure projects to invest in. Several multi-billion dollar infrastructure funds have already been assembled and more are being developed. This has led to the concept of having private firms build self-supporting toll roads that can tap these infrastructure funds for construction dollars.
This concept seems to be working effectively in France, Spain, Italy, Portugal, Indonesia, even China. But a quick scan of North America shows a landscape littered with the dry bones of failure and a rapidly aging cadre of privatization advocates. The smart money behind private infrastructure funds seems to be finding opportunities in every country except the United States.
Why Has the U.S. Fallen Behind?
Full-fledged privatization of transportation facilities has largely been a failure in the United States. The few successes have come only after years of complicated negotiations and a sad history of aborted projects.
California’s Assembly Bill 680 was passed in 1986 to stimulate construction of private toll roads throughout the state. Since then, negotiations have been completed with private firms for four such projects. But it wasn’t until late 1995 that the first one opened to traffic. This is the 10-mile, four lane, all-electronic toll road in the median of State Route 91 in Orange County. While its initial traffic volumes were less than originally projected, the growth has been encouraging and public acceptance of variable rate tolls and electronic toll collection has been good. However, no information has yet been released to show whether the road is a financial success.
The other three California projects have made little progress, largely due to state insistence on 100 percent private funding.
The experience in other states has been even more disappointing. In Washington, six projects were selected for development under the state government’s public-private partnership initiative. But a dramatic change in the political composition of the state legislation following the 1994 election resulted in anti-toll sentiment that virtually halted privatization efforts. The only project now underway is a series of park-and-ride garages in Seattle. But this project is funded entirely with public capital and is therefore not an example of true privatization. However, the Tacoma Narrows toll bridge project could end up as a truly private project if it survives a regional referendum in late 1998.
Virginia’s Dulles Greenway toll road was an ambitious privatization project that cost over $300 million and received substantial private equity (reaching as high as 50 percent of total capitalization at one point). But the highway has experienced low traffic volume and isn’t generating enough toll revenue to cover its debt service. Long-term economic growth in the region it serves could eventually solve this problem, but the road’s ownership may change hands several times before then. Meanwhile, the I-895 Richmond Connector Toll Road project has struggled to get past the preliminary stages and now appears to be stalled because of disagreement between the state government and private developers over how much private capital the developers should invest.
Arizona has been through three rounds of privatization attempts. Two ended in failure due to community opposition, poor economics and a lack of political support.
South Carolina’s experience with highway privatization has been mixed — one complete failure due to local opposition, one apparent success (the Greenville Toll Motorway), two more still in negotiation.
Only California’s State Route 91 and Virginia’s Dulles Greenway can be categorized as true private toll roads, because they embody the significant private equity investment and exposure to risk and reward that characterize all private sector undertakings. Both were conceived nearly a decade ago and neither is yet a financial success.
The other non-traditional toll roads are basically public-private partnerships, with government providing all or most of the investment capital while private firms do the building and operating. Most of the recent progress has involved projects that have little private investment and use phased construction to accelerate project completion. Their success seems to depend on:
- Having well-focused project goals, often determined in advance by government.
- Allowing the public and private partners to lead with their strengths. This usually means having government fund the project with tax-exempt debt, while the private firm takes on the phased-construction management responsibilities.
- Alternately structuring the project in ways that fall well short of true privatization and may simply involve some variation of the well-established “contracting out” concept (Virginia’s Interstate Maintenance program is an example).
Elsewhere in North America
In Mexico, the good news is that several major private toll roads have been built. The bad news is that most have been financial failures, even if political triumphs. In general, these projects were undertaken as ways to support Mexico’s construction industry. Tolls were set at high levels in the mistaken belief that this would permit rapid repayment of construction debt. But all this did was to discourage their use by motorists. While some smaller toll roads in urban areas appear to be self-supporting, most of these projects are in the process of being refinanced around lower and more realistic toll rates.
Canada has had at least one significant success with toll projects and few outright failures. This may be due to limited promotion of privatization for its own sake. The Northumberland Straight toll bridge between Prince Edward Island and the mainland opened during the summer of 1997. Its construction was privately financed, but it receives annual operating subsidies from the Canadian government from funds that formerly subsidized the ferries that the bridge replaced.
Route 407 outside Toronto has been a major success in terms of construction efficiency. But it was never promoted as anything more than a large-scale phased-construction project. Route 104 in Nova Scotia (a truck bypass around Halifax) may also end up as a hybrid success, with a combination of provincial government debt capital and private equity funding.
The Diagnosis
The problems faced in developing more private toll roads in the United States fall into three broad categories:
- The public sector’s access to ostensibly low-cost tax-exempt debt discourages consideration of alternate financing mechanisms.
- Poor communications between the public and private sectors. This includes a broad set of public sector approval processes that frustrate private developers and sometimes lead to outright failure.
- The multiple (often conflicting) objectives of private firms that can get in the way of structuring a reasonable deal for the project.
A key factor influencing project financing decisions is the access state governments have to relatively low-cost tax-exempt debt. When toll roads have promising economic prospects, government is usually reluctant to turn the financing (much less the project itself) over to a private partner.
One effort to get around this is the increasing use of “63-20 corporations.” These are not-for-profit corporations that the Internal Revenue Service allows to issue tax-exempt debt for private development. Even so, many private firms have been unwilling to make significant equity investments in toll road projects. They much prefer to serve as project developers in return for a flat fee. And the modest cost of establishing 63-20 corporations has discouraged some local governments from pursuing private sector participation.
With very few exceptions, private developers have been unable to convince public agencies that imagination and efficient management can offset the apparent financial benefits of tax-exempt debt. Ironically, financial advisors, the public finance arms of investment banking houses and other private players in the tax-exempt debt market are often the strongest advocates of maintaining the status quo.
Despite much apparent goodwill on all sides during the early stages of project development, private firms and public agencies often speak different languages, have different sets of values and follow different practices. Typical problems include:
- A different pace of decision-making. Public agencies are accustomed to a slower pace of decision-making than is usual in private firms, in part because there are more players involved. For example, environmental agencies and community groups can impose delays in the decision-making process.
- Government’s lack of a single decision-maker. Even when approval has been reached within one agency, another branch of government may change the rules (as happened in the state of Washington) or even halt the approval process (as Arizona’s governor did during the first round of privatization projects in that state).
- Government’s complex procurement process. The traditional practice of competitive bidding is often at odds with a private firm’s need to protect its proprietary ideas. Some states have been able to develop creative ways about this, as Virginia has done with its very short deadlines for bids. But all too often, private sector mistrust in the ability of public officials to follow through on good intentions leads to a lack of serious bids (as has happened in Delaware).
- Unrealistic financial expectations on both sides. Many public officials see the private sector as a source of easy money. But they fail to appreciate the need for a fair rate of return on private equity investments because of a suspicion that “private profits rob the public.” (Interestingly, this attitude seems to be less of a problem outside the United States.) At the same time few private firms have shown much willingness to make serious equity investments in projects. They tend to be more interested in getting paid to build toll roads than in the revenues such roads can generate.
- Limited support in public agencies. In many state transportation agencies, few officials are truly interested in private sector involvement. Most prefer to continue doing business as usual even if that means construction delays and higher project costs.
- Motorist opposition to tolls. This is widespread regardless of whether the toll collector is a public agency or a private firm. Despite funding shortfalls, there is often a stronger faith in the power of pork barrel politics than in the efficiency of the marketplace.
- Finally, private developers can fall just as blindly in love with their projects as public agency developers. A project’s underlying merits need continuing re-examination to determine whether changes in its scope are in order. A scaled-back Dulles Greenway could have brought costs more in line with actual travel demand. Instead of simply assuming that motorists “must” want to use the road originally planned, more up-front market research could have revealed demand levels that dictated a less ambitious road.
The Future
The first round of private toll roads in the U.S. has fared poorly. This has led to renewed emphasis on developing conventional public-private partnerships for public agency toll roads, often utilizing phased construction. But real opportunities still remain for truly private toll roads if three factors are kept in mind:
- Innovative project financing is still alive and well. The assumption that conventional tax-exempt financing by government produces interest cost savings shouldn’t obscure the larger financial benefits offered by other options. For example, federal law now permits state loans to private toll-road developers at below-market interest rates.
- The layered look is in. Private developers need to learn how to take full advantage of state infrastructure banks and other innovative public sector financial tools. Also, there’s no need to rely solely on tolls to support a privately developed road. It’s possible to take advantage of the increased property values and other economic benefits produced by a new highway to build a financing package around several revenue sources. Route E-470 outside Denver and the San Joaquin Toll Road in California’s Orange County rely on as many as five different revenue sources.
- Just do it. Private and public sector players too often have multiple objectives. All of which would be better served by a single-minded focus on getting the project built.
Four Questions Journalists Should Ask
Evaluating the viability of a new private toll road proposal is no easy task. But here are four questions for which journalists should seek answers.
1. Is the project kosher?
This involves more than simply determining whether the process for selecting a private developer is sufficiently objective to prevent the project from being handed to some politician’s favorite nephew. There have been too many instances of state governments’ selling an existing highway to a private firm for ready cash to plug a hole in the current year’s budget, then leasing the road back for annual payments that burden future budgets. Privatization projects must produce meaningful benefits for all concerned — including the general public.
2. Does the project have widespread support?
The surest way for a toll-road project to fail is for the general public to oppose it — because of anti-toll sentiment, a perception that the road is in the wrong place or not truly needed, or concern that it will have negative environmental consequences. It’s too easy for community activist groups to stir up political opposition or stall the project in the courts.
A second guarantee of failure is for the public agency sponsor to be anything less than fully behind the project. Officials who are unenthusiastic about a project have many ways to slow its progress until it lies dead in the water and the private developer decides to move on to better opportunities.
3. Is the project financially sound?
A private toll road must be self-supporting. This means generating enough revenue from tolls (and possibly other sources) to cover all its annual costs and provide a fair rate of return on the private equity capital invested to build it. If the road is owned by its private developer, standard accounting rules require that the annual cost of depreciation be charged against revenues. This is a way of recognizing the diminishing asset value of a capital facility as it gradually “wears out.”
To avoid having to set toll rates high enough to cover depreciation, legal title to a private toll road may actually be held by a public agency. For no sensible reason, public agencies in the United States are allowed to ignore depreciation as an annual cost, which eliminates the need for enough revenue to cover it. But at the end of the road’s useful life, new debt must be issued to reconstruct it. In effect, depreciation is simply capitalized rather than being paid for by today’s motorists.
4. Can the project produce significant benefits to society?
The underlying rationale for any transportation facility is that it supports and generates economic activity by making possible more trips in less time. A higher level of economic activity today means a more prosperous society tomorrow. But tolls can discourage tripmaking on a road that charges them, especially when toll-free roads are available as reasonable alternatives (one of the problems experienced by Virginia’s Dulles Greenway toll road).
Does this mean that we’re kidding ourselves by imagining that toll roads can provide a solution to our chronic pattern of under-investing in transportation capacity?
Not necessarily. California’s State Route 91 toll road is demonstrating that many motorists will pay extra for a faster trip. The trick is to find a toll structure that produces enough revenue without discouraging too many trips. Sometimes this can require artful ways of hiding or ignoring certain of the road’s annual costs so that toll rates can be lower. Capitalizing depreciation is one device for doing this.
Some people may be outraged by such blatant examples of “fiscal imprudence.” But the important thing is whether the overall result is, on balance, beneficial to society. If we can pay for increased transportation capacity in ways that don’t discourage its use, the result will be more trips and therefore more economic activity. Which is certainly beneficial to society, both today and tomorrow. And the size of tomorrow’s benefits determines whether capitalizing some of today’s costs may not be the most prudent thing to do.