The Facts About Toll Road Privatization and How to Protect the Public - U.S. PIRG Education Fund

 
The Facts About Toll Road Privatization and How to Protect the Public - U.S. PIRG Education Fund
The Facts About Toll Road Privatization
    and How to Protect the Public

         U.S. PIRG Education Fund
The Facts About Toll Road Privatization and How to Protect the Public - U.S. PIRG Education Fund
Private Roads, Public Costs
The Facts About Toll Road Privatization
         and How to Protect the Public

                 U.S. PIRG Education Fund
                                         Written by:
                            Phineas Baxandall, Ph.D.
                           U.S. PIRG Education Fund

                  Kari Wohlschlegel and Tony Dutzik,
                                      Frontier Group

                                    Spring 2009
The Facts About Toll Road Privatization and How to Protect the Public - U.S. PIRG Education Fund
Acknowledgments

The authors thank Robert Puentes of the Brookings Institution, Ellen Dannin of the Penn State Dick-
inson School of Law, Dennis Enright of NW Financial, and Michael Likosky of New York University’s
Institute for Public Knowledge for their thoughtful review and insightful suggestions. Thanks also to
Josh Bogus for his research support in the early phases of this project. Finally, thanks to Susan Rakov
of Frontier Group and to Carolyn E. Kramer for their editorial assistance.

U.S. PIRG Education Fund thanks the Ford Foundation for making this project possible.

The authors bear responsibility for any factual errors. The recommendations are those of U.S. PIRG
Education Fund. The views expressed in this report are those of the authors and do not necessarily reflect
the views of our funders or those who provided editorial review.

Copyright 2009 U.S. PIRG Education Fund

With public debate around important issues often dominated by special interests pursuing their own nar-
row agendas, U.S. PIRG Education Fund offers an independent voice that works on behalf of the public
interest. U.S. PIRG Education Fund, a 501(c)(3) organization, works to protect consumers and promote
good government. We investigate problems, craft solutions, educate the public, and offer Americans
meaningful opportunities for civic participation. www.uspirg.org

Frontier Group conducts research and policy analysis to support a cleaner, healthier and more democratic
society. Our mission is to inject accurate information and compelling ideas into public policy debates at
the local, state and federal levels. www.frontiergroup.org

For additional copies of this report, or to obtain a detailed listing of completed and proposed road priva-
tization projects across the country, please visit www.uspirg.org.

Cover: Photo by Geoffrey Holman, istockphoto.com; photo modification by Harriet Eckstein

Traffic sign images that appear on pages 5, 6, 17, 27, 27, 29 and 37 are from the Manual of Traffic Signs, by Richard
C. Moeur (http://www.trafficsign.us/) Copyright 1996-2005 Richard C. Moeur. All rights are reserved.

Design and layout: Harriet Eckstein Graphic Design
Table of Contents

Executive Summary                                                                      1
Introduction                                                                           4
What Is Toll Road Privatization?                                                       5
Privatization: Clarifying the Term                                                     5
Practical Considerations: When Does Privatization Make Sense?                          6
Defining Toll Road Privatization                                                       6

The Rise in Toll Road Privatization                                                    9
The Current State of Privatization                                                  9
Why Privatization Proposals Have Become More Common                                11
Vast Amounts of Private Money Are Seeking Toll Road Investments                    16

The Pitfalls of Road Privatization                                                17
Loss of Public Control                                                             17
The Public Will Not Receive Full Value                                             21
Private Companies Often Engage in Risky Financial Schemes                          27
Problems Compounded By Excessively Long Contracts                                  29
Lack of Transparency                                                               30
Inadequate Oversight Exists to Ensure the Public Interest is Protected             31

Protecting Against Bad Privatization Deals                                        35
Developing a General Approach to Toll Road Privatization                           35
Principles to Ensure Any Deal Protects the Public Interest                         37

Notes                                                                             39
Appendix A: Compensation and
Non-Compete Clauses in Privatization Agreements                                   46
Appendices B and C of this report, which provide detailed lists of completed and
proposed privatization projects, can be downloaded from www.uspirg.org/road-appendix
Executive Summary

R
      oad privatization is a growing issue in     Toll road privatization is becoming
      the United States as politicians and      increasingly prevalent in the United
      transportation officials grapple with     States.
budget shortfalls. Toll road privatization
takes two forms: the lease of existing toll     • Between 1994 and early 2006, $21
roads to private operators and the con-           billion was paid for 43 highway facili-
struction of new roads by private entities.       ties in the United States using various
In both instances, private investors are          “public-private partnership” models.
granted the right to raise and collect toll
revenue, a right that can amount to billions    • By the end of 2008, 15 roads had
of dollars in profits for the shareholders.       been privatized in 10 different states
   Though these privatization deals seem          – either through long-term highway
to offer state officials a “quick fix,” they      lease agreements on existing highways
often pose long-term threats to the public        or the construction of new private toll
interest. By privatizing roadways, officials      roads.
hand over significant control over regional
transportation policy to individuals who        • Currently, approximately 79 roads in
are accountable to their shareholders rather      25 states are under consideration for
than the public. Additionally, the econom-        some form of privatization.
ics of these deals are such that the upfront
concession payments are unlikely to match       • A few prominent examples of priva-
the long-term value of the higher tolls that      tized roads include:
will be paid by future generations and not
collected for public uses.                        o   The Indiana East-West Toll Road,
   Public officials, therefore, should ap-            which carries Interstate 90 approxi-
proach the idea of private toll roads with            mately 150 miles across northern
great caution, knowing that the short-term            Indiana and is a critical link be-
benefits are unlikely to outweigh the long-           tween Chicago and the eastern
term costs.                                           United States.

                                                                                             Executive Summary 
Figure ES-1. Privatization Projects Completed, Underway or Proposed, by State

                        For a detailed listing of completed and proposed privatization projects by state, please download
                        Appendices B and C of this report, available at www.uspirg.org/road-appendix.

                            o    The Chicago Skyway, which links              The upfront payments that states re-
                                 downtown Chicago with the Indi-              ceive are often worth far less than the
                                 ana Toll Road.                               value of future toll revenue from the
                                                                              road. Analysis of the Indiana and Chi-
                            o    California’s SR 91 Express Lanes,            cago deals found that private investors
                                 which were originally built by a             would recoup their investments in less
                                 private entity to provide a speedier         than 20 years. Given that these deals
                                 connection between Orange and                are for 75 and 99 years, respectively,
                                 Riverside counties.                          the public clearly received far less for
                                                                              their assets than they are truly worth.
                           Though privatization may offer
                        short-term relief to transportation bud-           • The public loses control over
                        get woes, it often has grave implications            transportation policy. Private road
                        for the public.                                      concessions in particular result in a
                                                                             more fragmented road network, less
                        • The public will not receive full                   ability to prevent toll traffic from be-
                          value for its future toll revenues.                ing diverted into local communities,

  Private Roads, Public Costs
and often the requirement to com-          • The public must receive fair value so
  pensate private operators for actions        future toll revenues are not be sold off
  that reduce traffic on the road, such        at a discount.
  as constructing or upgrading a nearby
  competing transportation facility.         • No deal should last longer than 30
                                               years because of uncertainty over fu-
• Public officials cannot ensure that          ture conditions and because the risks
  privatization contracts will be              of a bad deal grow exponentially over
  fair and effective when leases last          time.
  for multiple generations. No army
  of lawyers and accountants can fully       • Contracts should require state-of-the-
  anticipate future public needs. Trans-       art maintenance and safety standards
  urban, for example, has control over         instead of statewide minimums.
  the Pocahontas Parkway in Virginia
  for 99 years.                              • There must be complete transparency
                                               to ensure proper public vetting of
  In order to protect the public inter-        privatization proposals.
est, public officials must adhere to six
basic principles in all road privatization   • There must be full accountability in
agreements:                                    which the legislature must approve the
                                               terms of a final deal, not just approve
• The public should retain control over        that a deal be negotiated.
  decisions about transportation
  planning and management.

                                                                                          Executive Summary 
Introduction

                        D
                               ebates about the privatization of        question of public versus private provision
                               public services often devolve into       of government services, it is a matter of
                               ideological squabbles about the          where best to draw the line. There will
                        proper role of government versus the            always be a role for both public and private
                        private sector. Advocates of privatization      entities in meeting America’s transporta-
                        point to examples of government waste and       tion needs. It is up to elected officials to
                        bureaucratic inertia to make the argument       find the right balance to ensure that the
                        that the private sector can deliver services    public gets the value, efficiency and safety
                        more efficiently. On the other side, op-        it deserves from its transportation network
                        ponents of privatization offer stories of       – particularly at a time when our transpor-
                        corrupt contracting and the insensitivity       tation system is in dire need of repair and
                        of private entities to the broader public       when resources are scarce.
                        interest to argue for broader government            The task of government officials and the
                        involvement.                                    public is to evaluate privatization proposals
                           Yet, all but the most extreme advocates      rigorously – without ideological blinders
                        of privatization will acknowledge that there    – to ensure that any such deals benefit the
                        are some circumstances in which govern-         public interest.
                        ment must provide certain services directly.        Public officials must ask tough questions
                        Few, for example, would feel comfortable        if they are to safeguard the public interest.
                        taking bottom-line responsibility for the       In this paper, we evaluate one particular
                        delivery of “justice” away from our court       form of public-private partnership in trans-
                        system and giving it to a private, for-profit   portation – toll-road privatization – and
                        corporation. Similarly, few opponents of        suggest a series of guidelines public officials
                        privatization would insist that government      should adopt to ensure that any potential
                        should never contract out to the private sec-   private toll road deals benefit the public.
                        tor – whether for maintenance of the copi-          We hope this paper will help public of-
                        ers in government offices or the production     ficials navigate the difficult decisions sur-
                        of concrete for government buildings.           rounding toll-road privatization and make
                           In other words, when it comes to the         the right decisions to benefit the public.

  Private Roads, Public Costs
What Is Toll Road Privatization?

           Privatization:                       the basic problem of persuading the
                                                public that the terms of the partner-
           Clarifying the Term                  ship are fair.1

G
       overnment, the media, and the pri-        The term “public-private partnership”
       vate infrastructure industry use a     is particularly ubiquitous, and woefully
       variety of terms to describe efforts   imprecise. Virtually all public programs
to transfer public services to the private    have always involved some kind of partner-
sector. As one long-time scholar of infra-    ship between public and private sectors.
structure privatization at Harvard notes,     Medicare is a partnership between public
privatization has been packaged under a       financing and services by private medical
variety of names.                             providers, for instance. All government
                                              departments of transportation likewise
  Governments have experimented with          have a long tradition of using private ven-
  many variants of privatization, often       dors for various kinds of service provision.
  coining special terms—such as “peo-         Even transactions between two private
  plisation” (Sri Lanka), “capitalization”    companies involve some kind of partner-
  (Bolivia), or “equitization” (Viet-         ship with the public sector to underwrite
  nam)—to distinguish them from the           risks, define property rights, and enforce
  standard fare. And many consultants         contracts. Since “public-private partner-
  now prefer to use the term “public-         ship” can mean virtually anything, the
  private partnerships” to emphasize          term is of little descriptive value.
  that a wide variety of forms of pub-           The term “privatization” is more pre-
  lic-private collaboration is possible.      cise, denoting the transfer of traditionally
  Such changes in terminology may             public services or property to the private
  be useful, but they do not eliminate        sector.

                                                                                 What Is Toll Road Privatization? 
Practical                         • Third, privatization only succeeds
                                                                      when private contractors’ perfor-
                                  Considerations:                     mance is disciplined by ongoing
                                  When Does                           competition. There must be multiple
                                                                      contractors capable of submitting
                                  Privatization                       bids, and contracts must be for a short
                                  Make Sense?                         enough period to allow for unsatisfac-
                                                                      tory performers to be readily
                                                                      replaced.4
                        Practically speaking, privatization makes
                        sense for the public when certain condi-    • Finally, privatization works best when
                        tions are met.2                               the government officials making the
                                                                      decision to privatize can be held
                        • First, privatization works best when        accountable for the results of a
                          private companies have a proven             deal.
                          comparative advantage over gov-
                          ernment agencies in providing a par-
                          ticular good or service. For instance,
                          at least before recycling programs
                          were created, a variety of exhaustive
                          studies concluded that because smaller
                          municipalities lack economies of scale,      ?       Defining Toll Road
                          those that used competitive contract-                Privatization
                          ing for household garbage collection
                          had lower costs than comparable mu-       In this report, we focus on evaluating
                          nicipalities that used public agencies    proposals for toll road privatization to
                          for collection.3                          determine whether privatization of toll
                                                                    roads makes sense according to the criteria
                        • Second, the services that are priva-      described above.
                          tized must be well defined, with             Private toll road deals can involve lesser
                          clear criteria for the evaluation of      or greater degrees of privatization. On the
                          success or failure. It is less prob-      lesser side of the spectrum are small chang-
                          lematic, for example, to contract for     es such as the hiring of private contractors
                          private delivery of a ton of cement or    to mow grass or operate toll-collection sys-
                          for office windows to be washed each      tems. On the other side of the spectrum is
                          Friday than it would be to contract out   the construction of wholly privately owned
                          “justice” from the courts.                and operated highways.

                        Toll road privatization: When an existing roadway is leased to
                        a private company for a concession fee, or when a private entity
                        finances new road construction in exchange for the right to operate
                        and collect rising tolls on that road.

  Private Roads, Public Costs
“Availability Payments” Versus Toll Concessions

    B  y retaining the public’s right to set and collect tolls while more narrowly pre-
       scribing the private role, contracts that pay “availability payments” to private
    operators have a number of advantages over private toll concessions. The public
    retains greater control over transportation policy and will not be subject to non-
    compete clauses. Nor is the public liable to be sued for compensation when policies
    reduce toll traffic. Incentive clauses create a direct economic incentive to keep lanes
    available and in good repair.
       Availability payment deals still have many potential problems. Higher private
    borrowing costs mean that deals will still tend to lose the public money over the
    long term; and contract incentives still cannot anticipate future public needs. The
    public interest protections listed in this report would also apply to deals that involve
    availability payments. Moreover, the payments should not be overly generous com-
    pared to what it would cost the public to make these lanes available themselves.

   This paper focuses on two types of ar-            One example of such a deal is an
rangements: when an existing roadway is           agreement reached between the state of
leased to a private company for a conces-         Florida and the Spanish company, ACS,
sion fee; and when a private entity finances      for the construction and operation of
new road construction in exchange for the         express toll lanes alongside I-595. Under
right to operate that route over a specified      the arrangement, Florida will make annual
period of time. These arrangements share          “availability payments” to ACS over a
two characteristics. First, the government        35-year span to compensate the company
transfers rights tantamount to ownership          for the cost of building and operating
to a private entity. Second, the private          the highway. The payments to ACS are
entity receives access to toll revenues and       incentive-based, but the state of Florida
the right to raise tolls.                         retains the power to set toll rates and
   There are many types of arrangements           collect the revenue.5 The Florida deal,
that fall just outside of this definition         while clearly a “public-private partnership”
of toll road privatization. For example,          with a strong private-sector component,
governments have signed contracts with            does not fit strictly within the definition of
private entities to perform virtually all of      toll road privatization used in this report.
the services a government would perform              Another complicating factor in defining
in building and operating a highway               privatization projects is the use of non-
– ranging from design to financing to             profit intermediaries to secure preferential
ongoing maintenance – but without grant-          treatment for privatization arrangements
ing the private entities direct access to toll    under the U.S. tax code, IRS Revenue
revenues. In these cases, government still        Ruling 63-20. Local governments have
maintains ownership of the road as well as        traditionally issued tax-exempt debt in
a direct ability to withhold public funds         order to build schools, court houses or
from the private operator if the terms of         hospitals. Today, however, private com-
the contract are not upheld.                      panies establish these so-called “63-20”

                                                                                       What Is Toll Road Privatization? 
non-profits so that privatized projects can     63-20s can fit into the definition of “priva-
                         achieve the same favorable credit terms as      tization” used in this report.6
                         public agencies. In order to establish a 63-       Describing proposed toll road privati-
                         20, the local government must approve its       zation projects with exactitude is difficult
                         charter and the issue of its debt, giving the   because the precise relationship between
                         government title to its assets after the debt   a government and a private entity in oper-
                         is repaid. However, a loophole in the law       ating a road may not be determined until
                         allows an arrangement in which the gov-         a contract is finalized. As a result, while
                         ernment can then effectively disown the         we have attempted in this paper to use a
                         non-profit, which limits the government’s       relatively narrow definition of privatization
                         ability to be involved in the operations of     for completed projects, our list of proposed
                         the company. By law, 63-20s cannot make         projects includes a much broader range of
                         a profit, but private companies can cir-        potential arrangements. While some of
                         cumvent this restriction by receiving their     these roads may end up as fully privatized
                         compensation through development fees           highways, others will not. Including the
                         that are charged for consulting services.       broad range of potential projects is valuable
                         Though obviously an indirect way of earn-       despite this problem because it conveys the
                         ing a return on investment, this contriv-       variety of potential privatization projects
                         ance has nonetheless become a common            across the country and the potential stakes
                         way for private companies to seek publicly      involved for the public.
                         subsidized capital, and projects financed by

   Private Roads, Public Costs
The Rise in Toll Road Privatization

                                                   of public-private partnerships in highway
 CONSTRUCTION
                The Current State of               construction and operation.7
    AHEAD
                Privatization                         As of the end of 2008, 15 roads had
                                                   been privatized, and approximately 79
                                                   roads were either in the process of being

T
      hough rare only a decade ago, road           built by private entities or being consid-
      privatization has become increasingly        ered for privatization. (See “Tallying Up
      common in the United States. Cur-            the Number of Privatization Projects.”)
rently, 24 states and Puerto Rico have leg-        This privatization activity represents a
islation or regulations authorizing the use        substantial amount of money: from 1994

    Tallying Up the Number of Privatization Projects

    I n counting the number of privatization projects across the United States, we
      attempted to be as inclusive as possible, including projects at every stage of
    consideration from idle discussion to full-fledged proposals. Information about
    privatization proposals was gleaned from a variety of sources, which are described
    in detail in Appendices B and C to this report, which can be downloaded from
    www.uspirg.org/road-appendix.
       The privatization field is extremely fluid. Some proposed projects may have been
    dropped; others may have been put on hold. New projects may also have been pro-
    posed since the research for this paper was completed. Moreover, some proposals,
    particularly at the early stages, are vague about the role of private investment and
    involvement.
       In other words, the number of privatization projects described here represents a snap-
    shot in time and a relatively broad view of what constitutes a privatization project.

                                                                                     The Rise in Toll Road Privatization 
Figure 1. Privatization Projects Completed, Underway or Proposed, by State

                         For a detailed listing of completed and proposed privatization projects by state, please download
                         Appendices B and C of this report, available at www.uspirg.org/road-appendix.

                         to early 2006, $21 billion was paid during         seeking to build infrastructure. Accord-
                         this time period for 43 highway facilities         ing to World Bank records, infrastructure
                         in the United States using various models          privatization outside of the United States
                         (including models other than those consid-         reached a peak of over $110 billion per year
                         ered in this report).8 These numbers may           in 1997 and 1998.11
                         rise as more states attempt to overcome               Many infrastructure privatization deals
                         severe short-term budget deficits and meet         became high-profile failures. Two dozen
                         unfunded transportation needs.9                    private toll roads went bankrupt in Mexico
                            Common in the less-developed world              after 1994. The Thai government seized
                         for the last couple of decades, infrastruc-        one railroad that had been in private hands
                         ture privatization had not taken root in the       in 1993. Britain renationalized its rail sys-
                         United States until recently.10 During the         tem from Railtrack, the private company
                         1990s, infrastructure privatization became         that had purchased the rail system, in
                         increasingly popular in East Asia and in           2001.12 A World Bank study of over 1,000
                         Latin America, where Enron was a major             infrastructure projects in Latin America
                         investor. In those countries, unlike in the        and the Caribbean between 1982 and
                         United States, access to long-term capital         2000 found that 55 percent of privatiza-
                         was a major problem for governments                tion contracts in transportation and 75

10   Private Roads, Public Costs
percent in water and sewer had been rene-       budget, while money for major repairs is
gotiated, most during the first few years.13    taken from the Division of Capital Asset
Twenty-one toll road projects in Hungary,       Management, a separate agency. This set-
Indonesia, Mexico, and Thailand were sub-       up clearly creates an incentive for the de-
sequently taken over by the government.14       partment of transportation to under-invest
By the early years of the current decade, the   in road maintenance, because a separate
volume of privatization deals had returned      agency will be responsible for repairs.17
to the lower levels of the early 1990s.         Additionally, even when federal funds for
                                                maintenance are provided, public officials
                                                often divert them to the construction of
                                                new roadways, as a ribbon-cutting cer-
                                                emony tends to carry more political weight
                                                than maintenance projects. The result is
 EXPRESSWAY
    AHEAD
              Why Privatization                 deferred maintenance which necessitates
              Proposals Have                    expensive repairs in the future.
                                                   State governments today face immedi-
              Become More                       ate budget crunches due to rising health,
              Common                            pension, and unemployment costs, coupled
                                                with declining revenue. State legislators,
                                                who have already closed $40 billion in
Despite these experiences, privatization        budget gaps, face an additional $131 billion
is becoming increasingly common in the          shortfall between now and the end of the
United States as state governments attempt      2010 fiscal year.18 According to William T.
to overcome severe budget shortfalls. This      Pound, executive director of the National
trend has also been encouraged by federal       Council of State Legislatures, “These
policies meant to facilitate privatization      budget gaps are approaching those seen
agreements.                                     in the last recession, which were the worst
                                                since World War II, and show every sign
Budget Squeeze for                              of growing larger.”19
Transportation                                     Rising costs and declining revenues
Roads across the country are under strain       limit states’ ability to use general revenue
due to growing congestion and years of          funds to address transportation needs.
insufficient investment in maintenance.         Meanwhile, gas taxes, the traditional
The American Society of Civil Engineers         mainstay of transportation funding, have
has graded the overall condition of the         not kept up with inflation. For example,
nation’s infrastructure a “D,” and predicts     states’ gas taxes lost 43 percent of their
that $200 billion per year must be spent to     value during the 1970s, 80s, and 90s.20 The
maintain and improve the quality of the         federal gas tax, last increased in 1993, has
nation’s roads and bridges.15 This level of     done only slightly better. To complicate
investment will put a tremendous strain on      matters, Americans have begun to drive
state budgets, already experiencing short-      less in the past year, further reducing gas
falls due to declining revenue.                 tax revenue.
   Part of the problem is perverse rules           Furthermore, over the past few years,
that discourage investment in maintenance       construction costs have been rising due to
while encouraging construction of new           rapid inflation in the price of construction
roads.16 For example, in Massachusetts,         materials and the increased consolidation
the funds for highway maintenance come          of the construction industry. Though the
from the Department of Transportation’s         recent financial crisis has led to a deflation

                                                                                  The Rise in Toll Road Privatization   11
in construction costs, the historical trends       In the context of great investment needs
                         have contributed to the current shortfall in     and stagnant revenues, the huge upfront
                         transportation budgets. Over the past five       payouts of toll road privatization have obvi-
                         years, the cost of materials for highway and     ous short-term appeal.
                         street construction, as measured by the
                         Producer Price Index (PPI), has increased        Political Benefits of Privatization
                         by 63 percent, a rate far higher than the        Privatization of roads offers elected of-
                         general rate of inflation over the same          ficials political benefits beyond the ability
                         period.21 In particular the cost of crude        to avoid potentially unpopular tax increases
                         oil has led to very high costs for asphalt       to pay for transportation. In the short
                         and diesel, two of the most basic construc-      term, privatization promises a huge budget
                         tion materials used in highway and street        windfall, especially for privatization of
                         construction.                                    existing roads, which creates budget slack
                            While material costs have been increas-       and an ability to dedicate resources to other
                         ing, the number of bids that states receive      favored projects. New private roads offer
                         for contracts has been decreasing. While         special opportunities for credit-taking and
                         not as significant a factor as the cost of       ribbon cutting ceremonies. In either case,
                         materials, there has been a noticeable           the long-term financial downside, particu-
                         trend among states indicating that fewer         larly the loss of toll funds and rising toll
                         contractors are responding to requests for       rates paid by drivers, often is overshadowed
                         proposals. According to a survey of the          by the short-term windfall.25 For instance,
                         nation’s state transportation agencies, the      the Indiana Toll Road deal used a 75-year
                         reasons for this include 1) increased con-       lease to finance a 10-year transportation
                         solidation; 2) increased work with the same      plan. Whatever structural budget shortfalls
                         number of contractors; 3) downsizing of the      Indiana faced before the deal will return
                         construction workforce; and 4) increased         in the 11th year , but the state will need to
                         technical requirements in contracts.22 As        face these shortfalls without revenue from
                         fewer contractors respond to competitive         its toll road.
                         bid requests, states will be limited in their        Privatization may also be attractive to
                         choices to find the best contractor for the      elected officials because it gives them po-
                         lowest price, and prices will increase. Over     litical cover for toll hikes they fear will be
                         time this could become a more serious            unpopular. Potential investors claim that
                         factor behind highway construction cost          by outsourcing toll collection to a private
                         inflation.                                       company, drivers’ anger will not be direct-
                            As a result of revenue shortfalls and         ed at the politicians who authorized the toll
                         historically rising costs, states are increas-   hikes. Moody’s bond rating agency, after
                         ingly unable to build and maintain high-         conceding that governments can generate
                         ways at traditional levels. According to the     these same upfront payments by borrow-
                         American Association of State Highway            ing against future toll collections without
                         and Transportation Officials, the federal        privatization, offers the counterpoint
                         Transportation Trust Fund, used for state        that, “If they pursue the option [without
                         and local projects, is projected to run into     privatizing], governmental authorities
                         shortfall during 2009 and will need to re-       must take responsibility for their own toll
                         duce payments by 42 percent the following        raising decisions, rather than distancing
                         year unless new revenues are obtained.23         themselves from these decisions through
                         Many state-level transportation trust funds      a long-term concession to a private en-
                         are also forecast to run into shortfall in       tity.” 26 Fitch bond rating service, similarly,
                         coming years.24                                  lists as a merit of toll road privatization, the

12   Private Roads, Public Costs
ability to “distance government from toll       holders of road concession deals that last
increases.” The report explains that, “the      longer than the expected life of a road
political risk related to toll rate increases   (normally 40 years or more) as owners for
could be minimized by transferring the          tax purposes and allows them to depreciate
authority within an overall rate-setting        the value of those assets at an accelerated
framework to the private sector.”27             rate of 15 years. Senator Jeff Bingaman has
                                                described this as, “the tax tail wagging the
Federal Rules Promote                           dog: Exceptionally long leases in order to
Privatization                                   recover capital outlays on an accelerated
Policies by the Internal Revenue Service        schedule.”31 As an overview study by the
and particularly the Department of Trans-       Transportation Research Board of the
portation (DOT) have also promoted road         National Academies concludes, “This
privatization.                                  amounts to a government subsidy to the
   The tax code encourages privatization in     concessionaire that may significantly re-
a number of often unintended ways. As dis-      duce corporate taxes if the project proves
cussed earlier, many private projects take      profitable.”32
advantage of the IRS 63-20 rule to utilize         The U.S. Department of Transporta-
benefits meant for nonprofit organizations.     tion also subsidizes private road projects
The federal tax code also treats private        in a number of ways. The Transportation

    Aggressive Lobbying by the Private Toll Road Industry

    P  oliticians across the country have been lobbied extensively by the toll road
       industry hoping to profit off the public’s infrastructure. These lobbyists have
    made sizeable campaign contributions to numerous politicians across the country,
    hoping to encourage the adoption of road privatization projects.28 Though legal,
    these contributions raise the question of whether politicians can make an unbiased
    decision in the public’s interest when so much money is at stake. The following
    provides a sample of some of these contributions:

    • Zachry Construction Corporation, a company competing for Trans Texas
      Corridor projects, contributed $888,996 to Texas politicians from 2003 to
      2008.29

    • J.P. Morgan Chase, a member of A2 Transportation Partners, a consortium
      bidding to operate the Alligator Alley, contributed $100,000 to the Florida
      Democratic Party in 2002, and another $15,000 in 2008.

    • Abertis Infrastructures, a Spanish based road management company, spent
      $280,000 in 2007 and $465,000 in 2008 on lobbying efforts at the federal
      level.

    • Employees of UBS, which was part of the financing team involved in the
      proposed bid for the Pennsylvania Turnpike, donated $13,000 to Governor
      Ed Rendell of Pennsylvania.30

                                                                                The Rise in Toll Road Privatization   13
Infrastructure Finance and Innovation Act       due to significant public opposition to the
                         (TIFIA), passed in 1998, established funds      project, TxDOT eventually rejected the
                         for the federal DOT to spend on secured         proposal in favor of a bid by the North
                         (direct) loans, loan guarantees, and standby    Texas Toll Authority (NTTA), a public
                         lines of credit to attract private investment   entity. The deal with the NTTA was esti-
                         in surface transportation infrastructure.33     mated by some analysts to save the public
                         The TIFIA website lists $5.8 billion in past    $2.3 billion versus the bid from the private
                         or pending financing provided by the de-        vendor.37 In response, the FHWA sent
                         partment as of February 2009, with most of      a letter to TxDOT threatening to with-
                         it devoted to highway projects.34 The DOT       hold future federal funds for the project.
                         also publishes model legislation for states     FHWA argued that acceptance of NTTA’s
                         and a newsletter to encourage privatization     bid violated federal regulations requiring
                         of roads.35                                     a “fair and open” competitive process and
                             The biggest incentives are for private      rules prohibiting public entities from bid-
                         “green field” deals in which companies          ding against private companies. While the
                         construct a new toll road and then oper-        FHWA eventually backed down from its
                         ate it and collect tolls. The federal DOT       threat, many in Texas saw the exchange
                         allocates over $2 billion per year in credit    as an unjustified use of federal powers to
                         that can be used to subsidize private bor-      influence state decisions.38
                         rowing for highway and surface freight             In a more recent signal of its support for
                         transfer projects by exempting private          privatization, the Federal Highway Admin-
                         bonds from taxes. The DOT also grants           istration issued a rule in the Federal Regis-
                         private projects special federal waivers        ter requiring any future reorganization of
                         that suspend normal requirements on             public agencies to be justified on market
                         contracting, project finance, compliance        concession terms. What this essentially
                         with environmental requirements, and            means is that any time a state agency at-
                         right-of-way acquisition. For example,          tempts to reorganize or transfer authority
                         Oregon and Texas both received federal          over a toll road, it must first undergo an
                         waivers allowing them to begin negotiating      analysis to determine what price a private
                         contracts before the environmental review       company would bid to operate the highway
                         process had been completed.36                   under a concession agreement. When this
                             In addition to passing favorable regula-    concession price is determined, the public
                         tions, the federal DOT under the Bush           entity would be required to charge that
                         Administration actively lobbied state           amount to the other agency that is tak-
                         governments to approve privatization            ing over the roadway. Thus, if TxDOT
                         agreements. Then-Secretary of Transpor-         wanted to transfer authority over a road to
                         tation Mary Peters traveled to numerous         the NTTA because it thought the NTTA
                         states to encourage their use of private        was better suited to operate that highway,
                         investment, and tolling became an official      TxDOT would be forced to charge NTTA
                         key component of the DOT’s congestion           an amount equivalent to what a private
                         mitigation initiatives. In one instance, the    company would bid. After a large number
                         Federal Highway Administration (FHWA)           of private agencies and other stakeholders
                         even threatened Texas for pulling out of an     voiced concern during the public comment
                         agreement with a private company. The           period, the U.S. DOT revised the rule to
                         Texas Department of Transportation (Tx-         give agencies wide latitude to determine
                         DOT) initially accepted a proposal from         the criteria for market valuation. While
                         Cintra, a private company, to construct         the immediate effect of this ruling has
                         and operate State Highway 121. However,         been muted, it nonetheless set a troubling

14   Private Roads, Public Costs
precedent by establishing private conces-         been accusations of conflicts of interest by
sion deals as the standard.                       companies which analyze these deals and
                                                  prepare profit forecasts. In fact, a study of
The Potential for Low-Risk Profits                10 private U.S. toll roads built since the
In addition to the federal subsidies for          mid-1990s found that half have not met
green field deals, a number of factors            their traffic projections.39
make road privatization attractive to in-            Additionally, private infrastructure
vestors. One is the relative reliability of       deals often involve heavily leveraged debt
toll revenues. Compared to stocks and             and the trading of long-term risk, much
other investments, toll road privatization        like the mortgage industry in recent years.
is considered a relatively secure source of       Some analysts worry that such a model
long-term revenue. In addition, once a toll       will not be sustainable.40 A recent analysis
road concession is signed, it is very difficult   by PricewaterhouseCoopers describes the
to undo under U.S. contract laws. Toll            destabilizing pattern of leveraging debt and
profits reduce investors’ portfolio risk as       selling the risk to others that characterize
well, because the returns on these invest-        both the private infrastructure market
ments depend chiefly on traffic flow, which       and the now-infamous subprime mortgage
has historically been “recession-proof.”          industry:
Though there have been signs recently of
reduced driving, toll roads are still consid-           In the early 2000s, an increas-
ered a safe investment, especially in light of       ing number of large project finance
the current problems on Wall Street.                 lenders aggressively cut back on their
   There is some evidence that the reputa-           project and infrastructure finance
tion of infrastructure investments as “safe”         lending business or amalgamated
may be overstated. Many new private toll             them into their wider leverage fi-
roads have underperformed, and there have            nance business. This led to the now

Governor Corzine of New Jersey decided not to privatize or lease the Atlantic City Expressway,
Garden State Parkway, and New Jersey Turnpike (pictured here). Governor Corzine previously
served as CEO for Goldman Sachs, which advised structuring of the road privatization deals in
Indiana and Chicago. (Photo: Mark Gordon)

                                                                                   The Rise in Toll Road Privatization   15
well-practiced strategy of “originate          investment funds raised $25 billion in
                            and distribute,” often cycled through          2008, up tenfold from just $2.4 billion in
                            the dedicated securitization struc-            2004 (though down from the peak invest-
                            tures. … These were initially used             ment of $34 billion in 2007).42 A total of
                            to demonetize a bank’s balance sheet           77 such funds were active in the market
                            but then took on a life of their own           at the end of 2008, seeking $92 billion in
                            as they became conduits for banks              capital. 43
                            to originate business, take a fee, and            The recent financial crisis has caused
                            then sell on the exposure.41                   investment in private infrastructure funds
                                                                           to dry up, and has eroded the stock prices
                           Despite these concerns, there remains           of many funds. Yet, some fund managers
                         the perception that infrastructure invest-        believe that the financial crisis will be
                         ments are safe and sustainable.                   a boon to infrastructure investment in
                                                                           the long term. As Matthew Vickerstaff,
                                                                           the global head of infrastructure and as-
                                                                           set based finance at Societe General in
                                                                           New York, explained in BNET Financial
                                     Vast Amounts of                       Services, “The current crisis is good for
                             $       Private Money Are                     infrastructure funding because there will
                                                                           be increasing pressure on states, cities and
                                     Seeking Toll Road                     provinces to balance their budgets. They
                                     Investments                           will need to spend both for social and
                                                                           transportation infrastructure. They’ll need
                                                                           private money and private-public part-
                         With all these factors favoring toll road         nerships.”44 Thus, the number of private
                         deals, it is no surprise that private investors   road deals may increase as state and local
                         have been trying to take advantage of the         governments become more desperate for
                         profit opportunities. Private infrastructure      short-term infusions of cash.

16   Private Roads, Public Costs
The Pitfalls of Road Privatization

T
     he economics and governance of              quality of the roads, the many costs of driv-
     privatized roads are highly problem-        ing and car ownership, the availability of
     atic. For existing roads, outsourcing       high-quality and affordable public transit
borrowing against future toll revenue to         alternatives, and the development of future
a private entity is likely to generate less      land-use patterns. What may seem benefi-
money than a public entity could produce         cial from a narrow profit perspective does
with the same tolls. This is the case be-        not necessarily benefit the broader public
cause a private toll road operator will have     interest.45 Public control of key toll roads
higher borrowing costs and must divert           is therefore necessary to ensure coherent
some revenues to shareholder profits. In         transportation planning and policy making
addition to these fiscal problems, long-term     over long periods of time.
road contracts pose other serious threats            Any driver knows how events that take
to the public interest. These include frag-      place on one road affect other connecting
mentation and loss of public control over        and alternative routes. Thus, toll rates,
transportation policy, and the inability to      maintenance and safety standards, as well as
plan for future public needs in contracts        congestion on a toll road affect the number
that stretch over multiple decades.              of cars using alternative means of trans-
                                                 portation, including local roads and public
                                                 transit. Decisions about how to operate and
                                                 manage major roadways actually create traf-
                                                 fic policy for an entire jurisdiction.
                                                     New toll roads or additional lanes can
                                                 have particularly profound consequences
          Loss of Public Control                 for future land-use and development
                                                 practices as well as for a state’s energy and
Transportation policy has tremendous im-         environmental policies, including efforts to
pacts on quality of life, health, and the cost   reduce oil dependence, improve air qual-
of living. It determines the level of traffic    ity, and curb emissions of global warming
congestion and air pollution, the safety and     pollution.

                                                                               The Pitfalls of Toll Road Privatization   17
Road privatization experiences across       provisions are necessary for private entities
                        the country have shown that a private          to be able to sell bonds. If such a provision
                        operator’s profit motives lead to different    were not included, the state could eas-
                        management decisions than government           ily build a free, competing roadway that
                        might pursue. Examples from recent road        would divert traffic from the private toll
                        privatization projects illustrate these po-    road, eventually forcing the company into
                        tential dangers.                               bankruptcy. This actually occurred in New
                                                                       Jersey with the Beesley’s Point Bridge. The
                        Non-compete Clauses                            private bridge was originally built in 1927,
                        Toll road investors want assurances that       but in the 1950s a competing public bridge
                        traffic levels will meet or exceed predic-     was constructed only 300 yards away. Af-
                        tions, even in the event of toll increases.    ter the construction of the public bridge,
                        Some privatization contracts therefore         revenues from the Beesley’s Point Bridge
                        explicitly limit states’ ability to improve    plummeted, and the bridge was eventually
                        or expand nearby transportation facilities.    closed to traffic in June 2004. Recently,
                        The U.S. Department of Transportation,         Cape May County took over the bridge.48
                        in its Report to Congress on Public Private       Even when privatization agreements do
                        Partnerships (December 2004), strongly         not include an explicit non-compete clause,
                        supported the inclusion of such “non-          there may be an understanding between
                        compete” clauses to help attract private       the state and the private operator. For
                        investment.                                    example, Virginia had an “understanding”
                            In Colorado, one deal went so far as       with the private operator of the Dulles
                        to require adjacent municipalities to add      Greenway not to make improvements on
                        stop lights and reduce speed limits on         competing roads ahead of schedule (though
                        local roads as a way to reduce potential       VDOT eventually reneged on this under-
                        competition.46 Though the operator of the      standing).49 Concession agreements in both
                        road was technically a public entity, it was   South Carolina (Southern Connector) and
                        heavily financed by private investors who      Virginia (Pocahontas Parkway) include
                        demanded protection of future revenues.        vague language that prohibits the state
                        California, which used a private concession    DOTs from pursuing activities that could
                        deal to create new toll lanes in the median    be considered competitive in nature.50
                        of State Road 91, was subsequently forced
                        to buy back the road because non-compete       Compensation Clauses
                        clauses prevented the state from improv-       In place of non-compete clauses, many
                        ing the corridor and led to high-profile       agreements now include compensation
                        litigation. Similarly, Indiana is prevented    provisions requiring the state to com-
                        from building a four-lane, divided highway     pensate the private operator if its actions
                        more than 20 miles long (or expanding a        negatively affect toll revenues. The Indiana
                        current highway to Interstate standards)       deal, for example, requires the state to pay
                        within 10 miles of the East-West Toll          investors compensation for reduced toll
                        Road for at least 55 years without providing   revenue when the state performs construc-
                        compensation to the toll road operator for     tion, such as adding an exit or building a
                        lost revenue.47                                mass transit line down the median. This
                            Non-compete clauses are included in        compensation would add significantly to
                        many privatization contracts to protect the    the cost of construction, and the state
                        investors. A report by the Texas Legislative   could potentially not afford to do the work
                        Study Committee on Private Participation       it would otherwise perform. As an added
                        in Toll Contracts claims that non-compete      complication, the exact level of these fu-

18  Private Roads, Public Costs
ture payments might be subject to dispute         for income lost from diverted vehicles. But
and lawsuits. Already, the state of Indiana       from the public perspective, the diverted
has had to reimburse the private opera-           traffic may clog local roads, increasing
tor $447,000 for waiving toll collections         congestion and pollution in local com-
to assist in evacuations from flooding in         munities. There was substantial traffic
September 2008. Appendix A provides ad-           diversion, particularly of trucks, after the
ditional examples of these agreements.            1991 New Jersey Turnpike toll hike. New
   These compensation clauses are in-             Jersey responded by rolling back some of
imical to comprehensive transportation            the toll hike for trucks to entice them back
planning. Transportation policy should            onto the Turnpike, a move that would not
be made according to what is best for the         have been possible under privatization, at
public, not conditioned by avoiding extra         least not without paying the private firm for
payments to a private operator.                   the lost projected revenue. From a private
                                                  toll road operator’s perspective, gridlock
Profit-Driven Transportation                      and pollution on local roads may actually
Planning                                          be desirable because drivers will be more
Some privatization deals include monetary         likely to pay still-higher tolls. A study by
incentives for the state to divert traffic to     researchers at Penn State University and
the toll roads or decrease safety standards       Wayne State University found that the
in an effort to boost profits. Decisions to       private operation of toll roads could lead
build new roads are supposed to be made in        to increased accidents and maintenance on
accordance with long-term regional plans.         nearby public roads and lower quality of
The Texas contract with Cintra-Zachry for         life for residents on parallel roadways. The
SH-130 contains incentives for the state to       study also found large economic losses to
raise the speed limit on the private road.        nearby communities associated with diver-
The contract says that if the speed limit         sion of truck traffic.53
remains at 70 mph, the state will receive             It is important to recognize just how
4.65 percent of revenue up to a certain           much control over transportation policy
threshold. However, if the state raises the       is granted to private operators through
speed limit to 80 mph, it would receive 9         toll hike schedules for private operators.
percent of the revenues.51 Though state           If the rules for increasing toll rates under
officials have maintained they will not base      the Chicago Skyway toll road deal had ap-
speed limit decisions on monetary gain,           plied to New York’s Holland Tunnel since
this clause does create a strong incentive        its inception, that roadway could presently
for the state to toss aside safety, energy, and   charge a one-way toll of more than $180.54
environmental policy in favor of cash.            As a practical matter, an operator would be
                                                  unlikely to charge that price because nearly
Dangerous and Costly                              all drivers would instead take alternate
Traffic Diversions                                routes. But the operator would be free to
The goal of private toll operators is to find     charge whatever the market would bear to
the right balance of toll rates and traffic       maximize profits. Most agreements allow
to produce the maximum amount of rev-             toll increases to match inflation or GDP,
enue.52 Private toll operators can generally      whichever is higher. This may not sound
increase revenues by raising toll rates, even     excessive. But according to Professors
though the higher rates will cause some           Peter Swan and Michael Belzer, nominal
truck and car drivers to choose alternative       GDP has increased an average of over 7
routes. For the private operator, the ad-         percent for the past 50 years. Thus, with
ditional toll rates may more than make up         this average GDP growth, truck tolls could

                                                                                The Pitfalls of Toll Road Privatization   19
increase 3,976 percent over the life of the        outlays. Private investors want protection
                         roadway under the terms of the Indiana             against large increases in safety or main-
                         Toll Road agreement.55 Moreover, in order          tenance costs. As a result, road contracts
                         to maximize profits, the toll operator can         typically require private operators to meet
                         also offer discounts to particular types of        only generally applicable safety standards.
                         motorists and encourage traffic between            In order to obtain state-of-the-art highway
                         certain exits or at certain times. Together,       safety, Indiana must pay the additional
                         these provisions enable the operator to            cost of constructing and maintaining the
                         dictate who drives on the toll roads and at        road to the higher standards, as well as to
                         what times.                                        compensate the private company for any
                                                                            lost tolls caused by the construction.
                                                                               In the future, new standards may include
                         Inability to Guarantee                             things such as new surfaces, embedded
                         State-of-the-art Safety and                        road sensors, or technologies that are not
                         Maintenance Standards                              currently envisioned. The Chicago De-
                         The public may want major traffic arteries         partment of Transportation, for example,
                         to have cutting-edge safety technologies           has recently conducted a study which found
                         and traffic management. Private road               that using a new type of road surface that
                         operators, on the other hand, have an in-          includes recycled rubber is slightly more
                         centive to reduce costs by avoiding these          expensive than regular asphalt but creates a

                              Loss of Public Control: Camino Colombia Toll Road

                              T  he Camino Colombia Toll Road is a prime example of problems with lack of
                                 public control associated with privatization. The Camino Colombia Toll Road,
                              located in Texas, first opened to traffic in 2000. Completely financed by private
                              investors at a cost of $90 million, this road was intended to support the increased
                              traffic associated with the North American Free Trade Agreement.56 Politicians
                              predicted the road would be a “generator of regional economic activity” and provide
                              congestion relief. However, the road fell far short of its projections. An indepen-
                              dent auditor predicted that the Camino Colombia road would generate $9 million
                              in revenue within the first year, but instead it only received $500,000.57 By 2004,
                              the toll road had failed and bondholders foreclosed on the remaining $75 million
                              note. The road was sold at an auction for $12.1 million to John Hancock Financial
                              Services Inc. TxDOT had initially bid $11.1 million for the road, but was unwill-
                              ing to increase its offer. After purchasing the roadway, John Hancock Financial
                              Services, Inc. immediately closed the road to all traffic. This move forced TxDOT
                              to pay the private company $20 million to purchase the road, allowing it to finally
                              reopen the route after five months.58
                                 This clearly shows one of the pitfalls of privatization. Texas lost complete control
                              of transportation along the toll road, while a private entity had the right to close the
                              route regardless of the public consequences. Unfortunately, many transportation
                              officials do not appear to have learned from this experience, and future privatiza-
                              tion agreements may have similar results.

20   Private Roads, Public Costs
number of public benefits. It reduces strain      – be included with any contract; but they
on sewers and other water infrastructure          represent yet another area that govern-
because the surface is porous enough to           ment lawyers and accountants will need
allow water to return back into the ground.       to monitor.
It also creates an outlet for used tires that
are otherwise difficult and costly to dispose
of. Despite the potential public benefits, a
private operator would most likely be dis-
suaded from upgrading to this standard by
the extra costs.59
                                                    TOLL
                                                    AHEAD
                                                             The Public Will Not
    Even if high maintenance standards                       Receive Full Value
are specified in a contract, without proper
oversight private companies will have             Putting a fair dollar value on a long-term
a monetary incentive to under-invest.             toll road lease is difficult. As events of
Private operators may seek investments            the last year have shown, the state of the
that help attract drivers, but these are not      broader economy and financial markets can
necessarily the kind of safety, environ-          change quickly and dramatically, leaving
mental, and other investments that public         business plans and state budgets in ruins.
policy requires. Unfortunately, states have          The current crisis in state budgets makes
exhibited an inability to properly oversee        large up-front payments for toll roads dif-
private contractors in the past. The Fed-         ficult to resist. To give a sense of scale, the
eral Highway Administration, in a review          $1.8 billion sum paid for the 99-year lease
of quality assurance activities, found            on Chicago’s Skyway is enough to pay
numerous deficiencies “such as a lack of          every resident in Chicago a one-time sum
independent sampling of highway materials         of $643.61 The consortium that purchased
for verification tests; inadequate statisti-      a 75-year lease to operate the Indiana Toll
cal comparisons of the test results; and          Road paid an even greater sum: $3.8 billion.
insufficient state control of test samples,       Potential privatization deals for the New
sampling locations, and testing data.” They       Jersey and Pennsylvania turnpikes men-
also found that pavement on highways is           tioned payments between $10 billion and
deteriorating faster than expected, which         $30 billion. For elected officials struggling
they attribute in part to the weaknesses in       to plug chronic budget shortfalls, these
oversight.60                                      short-term windfalls are enticing.
    Private operators will have a greater in-        As impressive as the upfront payments
centive not to invest in improvements and         are, they pale in comparison to the likely
maintenance as they come under financial          value of the future tolls traded for them.
distress or approach the end of a contract.       The sums are smaller than public entities
Private operators should be required to           could generate doing the same financing
provide prior safeguards against this pos-        themselves.
sibility. For instance, for I-495 in Virginia        Financial analysis by experts in as-
the operator is required to provide a letter      set valuation confirms that privatization
of credit or performance bond that the            deals have failed to supply full value for
DOT can use if the roadway is not returned        the future tolls that private companies are
in proper condition. Public agencies can          expected to collect.
also retain a portion of tolls during the final
years of a contract and dispense them only        • Analysis of the Indiana and Chicago
if facilities are returned in good condition.       deals by Dennis Enright of NW
These kinds of measures can – and should            Financial, a New Jersey investment

                                                                                  The Pitfalls of Toll Road Privatization   21
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