Enterprise Zone

September 01, 2007

Like most states these days, Oklahoma faces a serious shortage of funds to maintain, repair, and expand its highway system. The principal highway funding sources—state and federal fuel taxes—have not kept pace with inflation, with rising construction costs, or with the extent of driving.

One alternative to either doing nothing or sharply increasing fuel taxes is to use toll finance to pay for new lanes and new roads in areas where demand is greatest. Other states and other countries have had considerable success with public-private partnerships for such toll projects. This is an alternative Oklahoma should seriously explore.

The Highway Funding Problem

Some people who realize that fuel taxes are the principal U.S. highway funding source balk at the idea of expanded use of tolling. After all, they maintain, we’re already paying at the pump for our roads; paying a toll in addition would be “double taxation.”

But that explanation begins to fall apart when you look at real numbers. During the 1960s and 1970s, when America built most of our Interstates and urban expressways, the fuel tax (on gasoline and diesel) produced about four cents per vehicle mile of travel. Today, however, after adjusting for inflation, fuel taxes average about two cents per vehicle mile of travel. In other words, our principal highway funding source is producing only half as much today as it did in the great era of highway building.

Most U.S. highways have a design life of about 30 years, before needing major reconstruction. That means much of the Interstate system and many of our urban expressways are nearing the time when, for safety and reliable-service reasons, they will need to be rebuilt. In growing urban areas and on major long-haul truck routes, we don’t have enough lanes to handle today’s traffic, let alone what’s projected for 20 years from now. So many of these roads will need to be rebuilt with more lanes. Given these grim facts, I am not surprised when I hear heads of transportation departments in state after state say that with existing funding sources, they can barely keep pace with routine preventive maintenance, let alone rebuild or expand their highway systems.

Traditional highway lobbies cite these kinds of facts to argue for major increases in federal and state fuel taxes. But the problem is not simply a lack of funding. It goes deeper than that, into the way in which decisions are made about which highway projects to fund. Many astute observers have concluded that the federal highway program, which once had the clear purpose of constructing the Interstate system, has lost its vision and rationale and become a conventional public works program. There are two aspects of this problem.

The first goes to the very nature of the federal funding system, which takes in the majority of its funding from large and fast-growing states (e.g., California, Florida, Texas) and redistributes it to small and sparsely settled states (e.g., Alaska, Montana, South Dakota). While this may have been necessary to get an Interstate built across Montana, it’s far from clear why we still have a mechanism in place that takes user-tax funding from where the need for expanded highway capacity is greatest and sends it to the places where that need is least. Yet that’s what the division of states into “donor” and “donee” is all about.

The second federal problem is that of earmarks for things like “bridges to nowhere.” Whenever Congress reauthorizes the federal transportation program (every six years), members of Congress can insert line-items in the bill, earmarking a portion of the funds for their state to specific projects that they favor. All too often, these are projects that the state’s own transportation prioritization process has ranked low on the list. But when Congress mandates funds for Project X, it must be moved up on the list, displacing projects that would have been more beneficial to more people.

The point of these examples is that the federal funding process systematically wastes scarce transportation dollars by funding low-priority projects at the expense of higher-priority projects.

There is also a perverse incentive at work at the state level. Every member of the legislature is under pressure to bring home the bacon to his or her district. Thus, it becomes politically necessary to divide up each year’s transportation budget among all the districts. A huge negative consequence of this process is that large “lumpy” projects—building a major new urban expressway or widening a major Interstate—have great difficulty being funded in anything other than bits and pieces over many years. Thus, their full benefits are put off until many years (or decades) into the future, and construction seems to be endless.

The Case for Tolling

State departments of transportation (DOTs) have pursued many forms of innovative finance over the past decade. Nearly all of them amount to some form of borrowing against future transportation revenues. This does have the advantage of getting some large “lumpy” projects funded up-front, so that their benefits (reduced congestion, smoother pavement, etc.) can be realized sooner, and paid for by those enjoying those benefits over the highway’s useful life. But all such methods merely rearrange the timing of existing sources of revenue; they don’t add to the total amount of investment into the highway system.

But using tolls to finance new lanes or a new highway or bridge is a very different story. We now have a completely new source of funds to pay for particular investments in new capacity. Moreover, in most cases the use of the new toll lanes will be optional—people have the choice of whether to pay to use them (if the benefits from doing so are worth more than the amount of the toll) or to continue using the existing lanes funded by fuel taxes.

There is a growing body of survey evidence (most recently a nationwide survey by the American Automobile Association) that people would prefer to have new highway capacity paid for by tolls rather than by an increase in fuel taxes. I suspect this is because many Americans have lost confidence in government’s ability to make wise use of any gas-tax increase. If they vote for such an increase, the only thing they can be sure of is that they will pay more at the pump. They may or may not get any relief from congestion or see any other improvements in highway quality. But if they opt for tolling, they know they will only end up paying tolls if toll lanes or toll roads are built where they can use them, and if they judge the toll to be a good value.

The Private-Sector Alternative

Oklahoma already has a number of toll roads, developed and operated by the Oklahoma Turnpike Authority, a specialized state agency. It owns and operates 605 miles of toll road, including I-44 and a number of other rural toll roads, plus the Kilpatrick and Creek Turnpikes in Oklahoma City and Tulsa, respectively. If Oklahoma needs new toll roads or toll lanes, why look to the private sector, when OTA is already in place?

This question has arisen recently in several other states where both state toll agencies and investor-owned toll road companies are in operation (e.g., Florida and Texas). The case for going with the existing state toll agency rests on its familiarity with local conditions, its ability to borrow at tax-exempt rates, and its ability to borrow against its existing base of toll revenues. But the large global toll road companies now active in the U.S. market have a number of points in their favor.

First, they can tap into larger pools of capital than just those investors who buy tax-exempt bonds. The last few years have seen the creation of more than a dozen global infrastructure investment funds, willing to invest equity into toll road deals. Investor-owned toll roads can also make use of bank debt and a variety of other structured debt instruments. They can finance a project over longer terms than the typical state agency. And because they pay corporate income taxes, they can make use of depreciation write-offs (which are worth zero to state agencies). All these factors mean that investor-owned toll companies are able to raise capital at rates competitive with those of state toll agencies.

And because they are dealing with less-conservative, less risk-averse investors, the toll road companies are willing to take on higher risks, by making more aggressive forecasts of traffic and revenue than state toll agencies. Hence, they can generally finance a larger amount than a state toll agency. That does not pose a risk to motorists or taxpayers, however, because under the long-term concession contracts used for such toll road projects, if the toll company defaults, the state can step in and take over the road, keeping it in operation. The investors, not motorists and taxpayers, are the ones at risk. And that very fact makes the company focus strongly on getting their projections right, controlling construction costs, and keeping the road well-maintained, so as to attract customers (who can always go elsewhere).

Investor-owned toll roads can also be developed on a multi-state basis. That is especially important for long-haul truck routes, which must connect City A to City B, regardless of state borders. A toll truckway designed especially for heavy double-trailer rigs makes no sense if it ends at an arbitrary state boundary line and the trailers have to be unhooked and hauled by separate tractors into the next state. Such a truckway needs to extend continuously from a logical truck starting point to a logical destination point.

Texas is well along in planning a new Trans-Texas Corridor parallel to I-35. The TTC-35 will include truck toll lanes, which should logically extend into Oklahoma, where I-44 could connect them to I-70, a major east-west truck route. Thus far, TTC-35 is planned only as far north as Dallas, but a Dallas to Tulsa to St. Louis toll truckway project (spanning three states) would be the kind of major project an investor-owned toll company could take on.

Long-Term Toll Concessions: A Proven Model

The basic model being used in Florida, Texas, Virginia, and others states involves a long-term contractual agreement (called a concession agreement) between the investor-owned toll company and the state DOT. In exchange for the right to charge tolls for a long period of time (typically, from 35 to 75 years), the company agrees to design, finance, build, operate, maintain, expand, and (as necessary) rebuild the toll road or bridge. Assuming the underlying economics make sense (i.e., demand strong enough to support enough toll revenue to make ends meet), the company can take this agreement to the capital markets and fund the project.

The concession agreement is typically several hundred pages long, and may incorporate detailed state highway standards by reference. It governs the basics such as the length of the agreement, provisions for amending it to take into account new circumstances, performance requirements and penalties, some mechanism controlling toll rates or the rate of return, possibly a revenue-sharing agreement, provisions enabling the state to buy out the company before the termination date, default provisions, and so on. Some have likened these agreements to marriage contracts, and they do create a public-private partnership in which the state and the company have a shared interest in the project meeting real transportation needs, consistent with both the public interest and the expectation by the investors of a return on their investment.

While this may sound like a radical departure from traditional U.S. highway practice, the idea actually has a long history. In a more rudimentary form, it was the model used for virtually all the 18th and 19th century U.S. and British turnpikes of the pre-automobile era. It was used in the 20th century for a handful of U.S. toll bridges (e.g., Detroit’s Ambassador Bridge), and is the basis for most of the post-World War II toll motorway systems of France, Italy, Portugal, and Spain. It was used for the huge Channel Tunnel between Britain and France, and also for nearly all the urban expressways in Sydney and Melbourne, Australia. In recent years the toll concession model has been adapted to the major countries in Latin America, and to meet the need for modern motorways in the former communist countries of Eastern and Central Europe.

And in the last 15 years it has been rediscovered in the USA. California and Virginia passed pilot programs in the 1990s under which three new toll projects were built successfully. Virginia expanded the idea into a major part of its transportation program, as has Texas and, more recently, Georgia and Florida. All told, nearly two dozen states have enacted some form of enabling legislation for public-private partnerships in transportation, and competitions are under way for projects in about half of them.

Will Oklahoma Be Next?

This article has only scratched the surface of an issue that warrants extensive discussion and debate. Texas went through such a process during the first half of 2007, debating the merits of expanded use of tolling and the extent to which investor-owned companies under toll concession agreements should be part of the program. It involved numerous questions including how long a concession term should be, what formula should be used to increase toll rates, whether foreign companies were a problem, what provisions should be used in early terminations, and how to deal with the potential problem of unlimited state competition with toll roads. In the end, Texas clarified the role of government toll agencies vis-à-vis investor-owned companies, reaffirmed its commitment to a major role for toll finance, and continued the heavy involvement (but with some new restrictions) of toll road companies.

Given Oklahoma’s looming shortfall in transportation funding, this is a debate the state needs to have. To be able to tap the expertise of toll road companies, and the global capital markets seeking to fund good toll projects, Oklahoma will need to pass enabling legislation. There are good models to draw upon in other states, and lots of experience worldwide about what works and doesn’t work. There is no need to reinvent the wheel on this. Having workable legislation in place would not commit the state to any particular toll projects. It would be simply another tool in the toolbox, enabling Oklahoma to consider the toll concession approach for those projects where it might make sense.

Oklahoma’s continued quality of life depends on excellent personal mobility, as well as an efficient goods-movement system. Both depend critically on adequate highway capacity, properly maintained. The status quo cannot deliver that. But tolling and long-term concessions could play an important role in doing so.

Robert Poole (B.S. and M.S. in mechanical engineering, Massachusetts Institute of Technology) is director of transportation studies at the Reason Foundation, a free-market think tank he founded in 1978. He has written hundreds of articles, papers, and policy studies on privatization and transportation issues. Poole is credited as the first person to use the term “privatization” to refer to the contracting-out of public services and is the author of the first-ever book on privatization, Cutting Back City Hall, published in 1980. Poole has advised the Reagan, George H.W. Bush, Clinton, and George W. Bush administrations on privatization and transportation policy, and has advised a half-dozen state DOTs on tolling and public-private partnerships.

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