I'm reading Peter Orzag's statement, from 7/10/08, when he testified before the Senate's Committee on Finance, and thought I'd collect some of the interesting bits and pieces, and offer some observations.
- Estimates from the Federal Highway Administration (FHWA) and other sources indicate that additional spending of up to tens of billions of dollars each year on transportation infrastructure projects could be justified. Some of that spending would simply maintain the current performance of existing infrastructure; other projects would improve performance to the extent that the economic benefits exceeded the costs (although some projects would have net benefits that were smaller than those that could be obtained from spending on items besides infrastructure).
- In general, additional federal spending for nontransportation infrastructure appears more difficult to justify. In some instances, the interaction of private producers and consumers in the marketplace determines an appropriate level of spending on infrastructure. In other instances, the case for a federal role might be strong, but the case for specific additional spending either is not well documented or is difficult to justify from an economic perspective.
- Although the rationale for some additional spending is probably strong, the economic returns on specific projects vary widely. Accordingly, even if the Congress were to increase spending, it would be important to identify which projects provided the largest potential benefit from limited budgetary resources.
- Some of the demand for additional spending on infrastructure could be met by providing incentives to use existing infrastructure more efficiently and by devoting current budgetary resources to their highest valued uses. For example, the Department of Transportation has reported that the demand for new spending on highways could be reduced by as much as $20 billion annually if congestion pricing were implemented to encourage efficient use of existing infrastructure.
- The question of whether projects are economically justifiable is distinct from determining who should pay for them. There is a strong economic rationale for charging beneficiaries for the costs of infrastructure. For example, it can be more efficient to impose taxes and fees on identifiable groups of users, such as drivers, than to rely on general revenues to fund an infrastructure project. Similarly, for projects whose benefits are mostly local or regional, state or local funding can be more efficient than federal funding.
- A special-purpose entity, such as a federally chartered infrastructure bank, could provide funding for infrastructure outside of the annual appropriation process but would not be a source of “free money”: Any reduction in the federal shares of project costs (obtained by reducing grant sizes or by shifting from grants to loans or loan guarantees with smaller subsidy costs) would require greater shares to be borne by project users, state or local taxpayers, or both. ...
Federal spending on infrastructure is dominated by transportation, which accounted for nearly three-quarters of the roughly $60 billion total federal investment in infrastructure in 2004. Highways alone accounted for nearly half of the total.3 Capital spending by state and local governments that year was primarily for schools, highways, and water systems. Together, those categories accounted for about $135 billion in state and local government spending, which is about 80 percent of the $170 billion spent on infrastructure by state and local governments.
In contrast, private-sector investment in infrastructure is dominated by spending on energy and telecommunications, which in 2004 represented nearly 80 percent of the sector’s total infrastructure spending of about $175 billion. Private entities provide most of the nation’s electricity and telecommunications services (typically, under federal or state regulation) and account for nearly all capital spending on those utilities. ...
Growing delays in air travel and surface transportation, bottlenecks in transmitting electricity, and inadequate school facilities all suggest that some targeted additional infrastructure spending could be economically justifiable. CBO’s review of the evidence suggests that tens of billions of dollars of additional infrastructure spending each year could be justified on an economic basis. The need for such spending, however, could be substantially reduced by user fees that encourage more efficient use of infrastructure. ...
Although capital spending on transportation infrastructure already exceeds $100 billion annually, studies from the FHWA, the Federal Aviation Administration (FAA), and elsewhere suggest that it would cost roughly $20 billion more per year to keep transportation services at current levels. Those studies also suggest that substantially more than $20 billion in additional capital spending on transportation would be justified on economic grounds if well targeted (because such spending would generate benefits whose value exceeded its cost). ...
Interestingly, Orzag's references to justifying projects on economic grounds do not appear to take any account of the notion that every worthwhile infrastructure project has the effect of raising land values.
... according to a detailed analysis that the FHWA provided to CBO, over
the next five years, investments required to maintain current levels of
highway service would represent 58 percent of the total spending for
all economically justifiable investments for highways, but they would
provide 83 percent of the net benefits.
Table 2 on page 8 provides information
about the potential for additional spending, but it provides no
information about who should pay. The “benefits principle” suggests
that federal taxpayers are often the least efficient source of
financial support for an infrastructure investment — after the direct
beneficiaries of the investment and local or state taxpayers.
From the standpoint of economic efficiency, the ideal is to charge
users of infrastructure according to the marginal costs of their use.
For example, people who use water can be charged for the costs of
acquiring, storing, treating, and distributing the water they consume.
One characteristic of many infrastructure services, however, is that some costs are not associated with anyone’s marginal use. ... However, they demonstrate the willingness of users to pay for the
services that are made possible by an infrastructure investment, and
thus they provide an indication of that investment’s efficiency.
(Indeed, the term “infrastructure demand” should arguably be reserved
for desires that are supported by beneficiaries’ willingness to pay.)
Although it is generally desirable from an economic efficiency
perspective, charging the beneficiaries of infrastructure investments
is not always feasible, even when the benefits of such investments
would exceed their costs. In some cases, the key problems are
technical, such as the limitations of 20th-century methods for
collecting highway tolls. In other cases, the difficulty arises because
the benefits are widely distributed and preventing nonpayers from
receiving the benefits is difficult or impossible, as in the case of a
dam that provides flood control services. In those instances, taxpayer
funding can be the most efficient solution, if the projects to be
funded are chosen on the basis of benefit–cost analyses.
Those whose property is protected by that dam will have increases in their property value as a result. It should not be off-limits for the purposes of funding that dam's construction and maintenance. Why on earth should we tax the federal taxpayer for that local bit of value?
Even with taxpayer funding, a version of the benefits principle still
applies: The more closely the group being taxed matches the set of
beneficiaries, the more efficient the investment decisions are likely
to be. In particular, if the benefits of a project are concentrated
locally or regionally, state or local governments spending their own
money are likely to be in a better position to make efficient choices,
weighing benefits against costs, than the federal government would be.
For example, partial taxpayer support for a mass transit system could
be economically efficient, to the extent that the system benefits
nonriders by reducing congestion on area roads. However, decisions
about the amount to invest might be less efficient if the taxes being
collected come from areas that extend beyond the region served by the
system.
Conversely, the case for support from federal taxpayers is strongest
for investments with benefits that accrue to broad geographic areas or
to the nation as a whole and are not restricted to a class of users
that can be charged more directly. Infrastructure with such widespread
benefits arguably includes the Interstate Highway System and wastewater
treatment plants for communities whose water eventually flows into a
major resource such as the Chesapeake Bay or the Gulf of Mexico. Even
when federal support for a given type of infrastructure is justified in
principle, implementation problems might make it undesirable in
practice. If the federal government decides to channel additional
infrastructure funds through state governments, some of those funds
ultimately might not finance additional infrastructure; instead,
federal funding might merely substitute for state and local government
funding, with little or no effect on the total.
In a section entitled "Economic Returns on Public Spending on Infrastructure," Orzag writes,
Another approach that sheds light on the appropriateness of additional
spending on infrastructure reaches broadly similar conclusions. In
particular, spending on infrastructure benefits the economy by reducing
the cost of private business transactions; over the past 20 years,
economists have attempted to measure those benefits and have obtained a
wide range of estimates. The literature supports two conclusions:
- First, public spending on infrastructure often produces positive economic returns, and second, there is significant variation — both in the average returns and in the range of returns among projects — that depends on several factors.
- Second, the research suggests that the returns on the initial phase of a system of public investments, such as the creation of the Interstate Highway System, can be large but that the economic payoff declines as the system grows.
Think about a few large projects: the George Washington Bridge, connecting New Jersey with New York City; the Verazanno Narrows Bridge, connecting Brooklyn and Staten Island, and the Tappan Zee Bridge, connecting Rockland and Westchester County, NY, and feeding traffic to NYC. Who benefited? Those who held land made valuable by the infrastructure investment. Those on both sides of the Hudson River, for many miles around. Those who owned land at both ends of each bridge, for many miles around. And Staten Island was no longer a ferry ride from all the rest of NYC. Did we collect from them? No. We didn't even try to record the value we created for them! What a deal! What nice people we are! We created HUGE amounts of land value, and deposited it into private pockets. And we continue to do so.
The Tappan Zee needs to be replaced. If its replacement bridge is not in place by the time that bridge is no longer safe to use, the northwestern suburbs of NYC across the Hudson will see their land values decrease, as those who live there will be caught in major traffic congestion getting to the jobs in NYC which finance their mortgage payments. Mortgage lenders will not be enthusiastic about lending there. Rents will drop off significantly.
The article, I think, gets some facts wrong in this next section, since tolls are only charged on the eastbound crossings of the Hudson River, but the discussion is instructive nonetheless:
Promote Reductions in Demand
Finally, the government could
reduce the demand for additional infrastructure by implementing fees
and charges that raise the cost to users of existing infrastructure.
One factor that can contribute to the high cost of infrastructure
services is that users often are not asked to pay the full marginal
cost of the services they use.
A classic case is the excessive crowding of a highway for which users pay no congestion charge.
In economic terms, society would be better served by reducing demand
for travel on such a highway during the hours when traffic is heaviest
instead of investing to increase the road’s capacity to accommodate
traffic. One way to reduce that inefficient demand is to impose
congestion pricing — that is, to charge tolls that are higher during
peak times of the day and lower during off-peak hours. Besides
dampening demand for the highway during the most congested periods —
some motorists would alter their travel plans and use the road when it
is less crowded, find alternative routes, or switch to public transit —
congestion pricing also helps to signal the places where additional
investment in road capacity is warranted. FHWA has estimated that
widespread use of congestion pricing would reduce by about $20 billion
per year both the investment required to maintain services in their
current condition and the total economically justifiable investment.
Congestion pricing is in use in the New York City area, for example,
where, since March 2001, the Port Authority of New York and New Jersey
has charged more for vehicles to cross the Hudson River during peak
hours than during off-peak hours. The crossing’s six bridges and
tunnels carry about 350,000 vehicles in each direction every day.
Initially, drivers who paid with cash were charged a $6 toll,
regardless of the hour of the day; drivers who used the E-ZPass
electronic toll collection system paid $5 during peak hours and $4
during off-peak hours — a 20 percent discount for off-peak E-ZPass
users. After the program took effect, traffic in the morning peak
period declined by 7 percent from May 2000 to May 2001, and evening
peak traffic declined by 4 percent (overall traffic volume remained the
same).30 Six percent of trucking carriers shifted their operations to
off-peak hours.31 Tolls from the Port Authority’s facilities raised
$750 million in 2006, more than covering their operating and capital
expenses.32 Those funds are used exclusively to build, operate, and
maintain transportation facilities in the New York–New Jersey area.33
Tolls on the crossings went up March 2, 2008. The cash charge is now
$8; E-ZPass rates are $8 during peak hours and $6 during off-peak hours.
Similar pricing systems have been adopted for more than half a dozen
bridges, tunnels, and highways in the United States. In Orange County,
California, express toll lanes built in a 10-mile section of the median
strip of State Route 91 give motorists a choice between driving in
toll-free lanes and driving in new lanes on which tolls are charged
according to time of day. More than a dozen similar highway capacity
expansions are either in operation, under construction, or in planning.
On Interstate 15 in San Diego, drivers of single-occupant vehicles may
pay a toll to use high-occupancy vehicle (HOV) lanes. At least a half a
dozen existing HOV lanes have been converted or soon will be converted
to “high-occupancy toll” (HOT) lanes.
The concept of marginal-cost pricing extends beyond congestion, however. To
maximize efficiency, users would be charged for all of the incremental
costs they impose on the system. For example, the incremental damage
imposed by trucks on highways does not depend on a vehicle’s total
weight but rather on its weight per axle.34 Because that fact is
not reflected in the current taxes on truck ownership and use, there
are wide disparities in the degree to which different types of trucks
pay the cost of the highway damage that is associated with their use.
For example, researchers have estimated that the taxes paid for a
five-axle tractor–semitrailer with a gross vehicle weight of 55,000
pounds on rural interstate highways are about 20 percent more than the
marginal cost of use. In contrast, the taxes paid by a vehicle with the
same configuration and a gross weight of 80,000 pounds represent only
one-third of the marginal costs on rural interstate highways. Marginal
costs on urban interstate highways, which are more expensive to repair,
or on lighter-duty roads, which incur more damage, are even higher.
Instituting charges that are tied to axle weight and to the number of
miles traveled by a truck could reduce the need for spending on
highways by inducing motor freight carriers to reconfigure their
vehicles or shippers to switch from trucks to rail. If the charges also
varied by the type of road, some carriers might adjust their routes to
travel on more durable roads.35
Privately run or owned toll roads
Public–Private Partnerships
Some advocates of increased spending on infrastructure suggest that
greater use of public–private partnerships (PPPs) would facilitate such
increases. (A PPP is an institutional arrangement in which a private
entity assumes some level of risk beyond that traditionally associated
with supplying its services to a government agency.) In the
infrastructure arena, such partnerships appear to be most common for
projects that lend themselves to private operation: roads, rail, and
water supply and wastewater treatment. A private entity could control
access to and charge for the use of a toll road or a drinking water
system, for example, but it would be harder to charge users to recoup
costs given the more diffuse benefits from a dam or flood control
project.
Public–private partnerships can take a variety of forms that differ in
the amount of risk assumed by the private entity. For example, private
entities bidding on long-term contracts to supply services, such as
maintaining public roads or operating water supply facilities, would
face relatively modest risks concerning their ability to deliver
services at the agreed-upon price over the length of the contract.41 In
other cases, however, the private entity could have almost complete
responsibility for the project and accept a variety of risks, including uncertainties about construction,
the cost of financing, and the demand for the infrastructure that it
provided. In some public–private partnerships for road construction,
for example, the private entity could raise most or all of the funds
and also would be responsible for design, construction, operation, and
maintenance. That entity would recoup its investment through user
fees.42
PPPs have been used in many other cases to obtain private-sector financing of new toll roads, including the Dulles Greenway in Virginia and the State Route 91 and State Route 125 toll roads in California. PPPs also have been used to finance transit projects, such as the Hudson–Bergen Light Rail system in New Jersey, and freight railroad projects, including the Alameda Corridor in Los Angeles.
The potential advantages and disadvantages of PPPs include the possible reductions in investment requirements that would come with more efficient management (including cost-based pricing) and the potential increases in the costs of financing, respectively. Whether the use of private management in PPPs would help to reduce total spending on infrastructure depends on the extent to which savings from improved asset management exceed the costs of using the private services. To maximize profits, a private partner might reduce life-cycle costs through higher construction standards, more frequent maintenance, or investments in cost-saving technology. Efficiencies also could result if a private entity charged prices that were more closely aligned with costs, thereby reducing inefficient demands for services and thus perceived investment needs. However, if there is insufficient competition, public oversight could be needed to guard against the risk that the private entity might use monopoly power to raise prices excessively.
As I'll go into in a separate post, we-the-people lose a significant source of revenue when we permit the privatization of land value, and as we contemplate significant investments in infrastructure, we ought to be focusing on how to make the effects of that investment go as far as possible, not lodge in privileged pockets, as is our tradition.
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