Future Prospects for Transportation Financing
Finding 21st Century Funding Solutions to 21st Century Fiscal Problems
Remarks by C. Kenneth Orski, Editor/Publisher of Innovation Briefs at the Transportation Leaders Meeting, National Conference of State Legislatures, San Antonio, December 5, 2006
Thank you for inviting me to be a part of your meeting on the transportation challenges confronting state legislators. With the federal transportation program coming up for reauthorization in 2009, it is a timely subject. As some of you may know, I have been reporting and interpreting transportation news for a good many years. And it is as a long-time observer of the transportation scene that I would like to report to you today on what I see as the current trends in transportation financing and where they are taking us in the years ahead.
I shall focus my remarks on two issues:
The emerging role of tolling and private capital in highway financing;
The implications of these trends for the state-federal relationship.
Growing Interest in Tolling and Road Pricing
That there is a high level of interest in highway tolling is no longer in dispute. A survey conducted by the U.S. General Accountability Office (GAO) shows that as many as 23 states have plans to build toll facilities. Of these, 17 already have toll facilities and 6 are planning their first toll roads or toll lanes. [The 6 states are Alabama, Mississippi, Missouri, North Carolina, Oregon and Washington. Highway Finance: States’ Expanding Use of Tolling Illustrates Diverse Challenges and Strategies, June 2006, GAO-06-554.]
Back in February of this year we looked at the rising level of interest in tolling and concluded that highway tolling has reached the "tipping point." We wrote: "Virtually every week brings fresh evidence that highway tolling and private financing are gaining new converts among governors and state transportation officials, in state legislatures, and in the media. Growing transportation budget shortfalls, eroding value of highway tax revenues and a supportive federal policy have helped to nurture these ideas. Fanning their spread are visions of highway projects built entirely with private funds and prospects of multi- billion-dollar concessionary cash payments that could jump start ambitious transportation improvements years in advance of their planned execution." (Innovation Briefs, January/February 2006).
Since then, we have been able to document over 60 distinct tolling initiatives in 17 states. The new projects bear little resemblance to the toll roads of past generations. They take a variety of innovative forms such as conversion of existing HOV lanes to High Occupancy/Toll (HOT) lanes, construction of new express toll lanes, introduction of variable pricing on existing toll facilities, and plans for truck-only-toll (TOT) lanes. Few of these projects are being planned as entirely new toll roads. Most of them involve adding priced lanes in established highway corridors. Some of the new toll facilities are intended to double as transitways for express bus service. And many will be built in partnership with the private sector.
Why is interest in tolling growing?
There are, I believe, two explanations for the high level of interest in tolling: one is theoretical, the other pragmatic.
Tolls, we are told, are a true road user fee as contrasted with the per-gallon fuel tax which is only a surrogate measure of use. In a toll-based system motorists pay only for the actual use and the wear and tear of the roads they travel on. The collected money remains in the jurisdiction – often in the same corridor– that provides the service. Variable tolls allow road operators to charge for the actual marginal cost that individual users impose on the facility. Finally, market-based pricing allows for a more rational resource allocation — it helps direct scarce resources where additional road capacity is most needed.
But what is really driving the growth of interest in tolls is not their theoretical virtue but a set of very pragmatic considerations. State transportation officials tell us that tolls are the only way they can finance new road capacity because most of their budget already goes into maintenance and reconstruction of existing roads. Tolling allows states to build new roads that otherwise would remain on the drawing board for many years if they had to be funded with traditional pay-as-you-go financing. Another motive for tolling is to augment current gas tax revenues to meet shortfalls in local transportation budgets – shortfalls that many states are struggling with these days.
The often unstated assumption behind this thinking is that state legislatures and the U.S. Congress will continue to be reluctant to raise fuel taxes, no matter which party is in power. In order to close the funding gap, many states would have to increase local fuel taxes to a level that voters would find exorbitant. For example, a Washington State Transportation Commission report estimates that it would take an increase of 50 cents/gallon to close the State’s road funding gap beyond 2009, assuming that the federal contribution remained unchanged. (Washington State Comprehensive Tolling Study, Final Report, September 2006).
At the federal level, fuel taxes would also need to be increased significantly— about 27 cents/gallon* according to recent estimates. So, I see little prospect for congressional action on a gas tax increase, certainly not during the next session of Congress and probably not in the 111th Congress as well. (* based on "average annual gap to improve " of $119 billion during 2007-2017 or about 60 cents/gallon, as estimated in a forthcoming report, Future Financing Options to Meet Highway and Transit Needs, NCHRP 20-24(49). A one cent increase in the fuel tax is assumed to generate an annual sum of $1.95 billion in tax revenue. The federal share of the 60 cent increase is assumed to be 45%, based on the historic federal share of capital investment in highways.)
Eventually a mileage-based tax may replace the fuel tax and provide a more adequate source of revenue. But implementing a mileage-based tax system would involve difficult problems of transition. It is, at best, a solution for the distant future. A Transportation Research Board committee concluded that the fuel tax will be with us for at least the next 15 years. Until then at least, tolls appear to many state transportation authorities as the most logical and practical source of revenue with which to supplement the eroding value of the gas tax. The public seems to share this point of view. According to a recent AAA nationwide survey cited by Mr. Darbelnet this morning, 52 percent of respondents were in favor of some form of tolling to help finance transportation facilities, while increased motor vehicle fuel taxes received support from only 21 percent.
Tolls as a Tool of Demand Management
There is another reason why interest in tolling is rising : tolls are seen as a tool for reducing traffic congestion. And congestion mitigation has become an important policy objective at both state and federal level. Variable pricing — where tolls go up and down with the level of demand— allows highway operators to adjust the flow of traffic dynamically, and thus maintain the lanes relatively free of congestion even at the height of rush hour.
At the same time, priced lanes are becoming increasingly accepted by the driving public. Electronic toll collection technology has eliminated a major public objection to tolling because drivers are no longer required to stop at toll booths. Most importantly, toll lanes offer a tangible option to getting stuck in traffic. Surveys show that even drivers of modest means choose to pay tolls when they are pressed for time. The term "Lexus Lanes," once used as a pejorative shorthand for toll lanes, is disappearing from usage.
A graphic example are commuters in Northern Virginia’s Loudoun County who have a choice of two parallel routes into Washington — one is a toll-free state route (Route 7), the other a privately operated toll road, the Dulles Greenway. Tens of thousands of commuters are opting to pay a daily fee of $10.80 on the free-flowing Greenway in order to avoid the stop-and-go traffic on the state route. And by the way, most of them drive Fords and Chevrolets rather than luxury cars.
Increased Role of Private Capital in Highway Development
A related new trend in highway financing is the growing role of private investment capital. This has taken two forms: long-term private concessions or leasing of existing toll roads; and construction and operation of new toll roads and toll lanes by private consortia.
Here again, budgetary constraints are the main reason for increased private sector participation. Public officials tell us they welcome private capital much for the same reason they have come to accept tolls: to supplement their inadequate transportation budgets. As Indiana’s Governor Mitch Daniels likes to point out, thanks to the up-front lump sum payment received from the lease of the Indiana Toll Road, the state has a fully funded capital program of highway construction for the next ten years. Few projects in this program would be constructed had Indiana continued to rely on traditional funding mechanisms.
Involving the private sector, we are told, also has other advantages. It offers access to private equity capital. It allows state governments to build projects sooner than with traditional pay-as-you-go financing. It shifts the risk of cost overruns and over-optimistic traffic forecasts to the private concessionaire. Private toll road operators have often shown themselves to be more entrepreneurial, innovative and customer-oriented. And lastly, under private management, toll rates can be raised to control demand or fund needed improvements without the fear of political interference.
That is not to say that private toll road concessions should be left completely unregulated. Rather, like investor-owned utilities, their performance, rate making decisions and customer satisfaction can be closely scrutinized by public authorities and controlled through contractual conditions written into concession agreements.
There is another reason for the rising level of private investment in transportation infrastructure. Private capital markets have discovered that toll road concessions offer attractive long-term investment returns. While most of the money so far has come from foreign sources, our own venture capital does not intend to be left behind. Many private equity funds and major investment banks on Wall Street have created — or are in the process of creating— infrastructure funds with transportation as a major component. By the end of the decade we may see as many as a dozen such funds.
Some time ago, the New York Times observed, "Tolling is shaping up as one of the biggest philosophical changes in transportation policy since the toll-free Interstate highway system was created under President Eisenhower in 1956." (NYT, 4/28/2005). The Times editorial speculation turned out to be true. Growing acceptance of tolling and a willingness of private capital to invest in transportation infrastructure are indeed influencing our approach to highway financing. It is quite conceivable that toll facilities will constitute the bulk of all future additions to the nation’s highway capacity, and that private capital rather than tax dollars will become the chief source of financing new road construction.
However, I cannot stress enough the words "future additions" and "new road construction." There is strong public opposition to converting existing free lanes to toll lanes and this opposition is likely to continue. Tolling existing highways, at best, is a policy for the more distant future.
Implications for the States
There is an aspect to these trends which should be of particular interest to you, state legislators. A widespread use of tolling, combined with greater reliance on private sector financing could fundamentally modify the traditional state-federal relationship in transportation.
If toll revenue and private capital became the primary means of financing new highway capacity, a major federal responsibility — construction of new roads— would be shifted to the states and their private concessionaires. Such a de facto devolution of the federal role would lessen the pressure on the Highway Trust Fund since its resources could henceforth be devoted mostly to helping preserve and rehabilitate the Interstate system and other existing highway assets. State transportation funds would likewise come under less pressure, much for the same reason.
This morning we heard some observations about two competing views of the world: one view envisions the need for new approaches to transportation financing and a greater role for the states; the other view emphasizes traditional tax-based financing and a strong federal role in transportation investment. Rather than seeing these two views in opposition to each other, I see them merely as a reflection of a new division of responsibility, necessitated by new fiscal realities. The federal tax dollars will continue to be needed to support the vital mission of maintaining and reconstructing the existing highway system. The states, on the other hand, will assume primary responsibility for financing new infrastructure. They will do so not with borrowing or tax dollars but with the help of tolls, private capital and public-private partnerships.
A New Vision
We also talked this morning about the need to develop a new vision. Imagine, if you will, a long-term program (extending very likely over several decades) of creating networks of express toll lanes in major metropolitan areas of the nation. Imagine further multi-state systems of toll truckways in freight-intensive corridors. As existing toll-free roads became clogged with traffic, individual motorists, shippers and truck operators, I suggest, would switch to these premium-service congestion-free toll facilities in sufficient numbers to ensure their financial viability and attractiveness to private investors.
The toll networks would be financed, built, and operated as private concessions, financed largely with private capital. Just like other investor-owned public utilities, they would be subject to state regulatory oversight, but would be managed like a business and have strong customer service orientation.
What is currently happening in the states of Texas, Virginia and Indiana may be a harbinger of this transition to a public utility model. All three states view privately financed toll facilities as a means of expanding road capacity without public borrowing or a tax increase. In Texas, long-term private toll concessions will help fund seven segments of the Trans-Texas Corridor (TTC-35)— an initiative that owes much to my fellow panelist, Mike Krusee. In Northern Virginia, express toll lanes, paid for largely by the private sector, are being added to expand the capacity of the Capital Beltway and I-95. And, in Indiana, Gov. Mitch Daniels has just announced an ambitious new project – construction of a 75-mile circumferential toll road around Indianapolis– utilizing a public-private partnership to build, operate and maintain the facility without, in his words, " a penny of borrowing or a tax increase." In all three cases the state will retain control over toll rates and require the private concessionaire to maintain prescribed levels of maintenance and service.
These three states are the trailblazers. They are pioneering, to paraphrase Transportation Secretary Mary Peters, "21st century funding solutions to 21st century fiscal problems." May I respectfully suggest that you, too, should consider these approaches as worthy of your consideration as you seek to address your own state’s transportation needs.
Thank you again for the opportunity to be with you today.
 Transportation Fall Forum Presentations 2006
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