Private Funding an Important Option for Missouri Highways

An economic crisis is an excellent time to question assumptions — some of which may turn out to have been very harmful. Perhaps the notion that everybody should be homeowners, disregarding affordability, was not such a good idea. On the other hand, some assumptions may have become conventional wisdom because they were indeed correct all along. For instance, if insurance companies are not legally required to maintain a reasonable level of liquid holdings for use as a safety valve, they have little practical incentive to do so. A recent Show-Me Institute study questions many common assumptions related to transportation policy and funding.

The study’s author, Kenneth Small, an economics professor of the University of California at Irvine, asks whether capacity expansion is always the best way to deal with congestion. New, privately financed capacity that is paid for by tolling does not result in losers among either users or taxpayers; drivers can choose to use the old, free roads, and taxpayers aren’t stuck with the construction bill. But what about altering existing highways to set toll rates that vary based on the time of day, or on observed traffic patterns? Although Missouri’s Constitution does not currently allow for this, it’s an important issue to consider, because adding capacity without instituting a pricing mechanism serves as an incentive for more people to drive during peak periods. This increases the congestion that the new capacity was intended to relieve. Variable rate tolling would create an incentive for those who want to drive quickly to pay for the privilege of an uncongested road during rush hour. It would still allow others to drive for free, in slower traffic, if they prefer. Most importantly, by allowing such a choice, this form of tolling can serve as a powerful incentive for those with greater time flexibility to stay off the road entirely during peak periods.

Another common assumption is that the private sector is more efficient than the public sector. While this belief is correct in many respects, it’s worth investigating whether it applies in transportation. There are few industries with as much crossover between the public and private sectors. Regardless of whether a road or bridge is publicly financed and bid out, or privately financed and built, the same major construction companies are usually involved. Those companies operate as efficiently as possible, whether they are working on public or private projects, and prevailing wage laws mitigate the wage differences for public projects.

Research has shown that in some areas, such as bus transportation, the private sector operates with significantly lower cost than the public. But much of this can be attributed to the lower wages and benefits paid to non-unionized workers. What about real efficiency gains that go beyond doing the same thing at a lower cost? Small details how using the private sector may enhance efficiency by leading to greater flexibility and innovation, and more precise planning. More important, though, may be the improved management incentives, whether in a public or private organization; increased use of the private sector is one way to address this. These incentive systems comprise the rewards and punishments, primarily financial, that result from management risks and decisions. Despite the best efforts of some public agencies to match the potential incentives and rewards of the private sector, the legal conditions under which they spend public money will not allow them to do so.

Perhaps the most important assumption Small discusses is the seemingly obvious idea that public-sector financing is cheaper than private financing. Public entities can offer tax-exempt bonds that result in lower interest rates for taxpayers, but the study demonstrates that there is more to be considered before one can conclude that public financing is cheaper every time. If a public bond is financed at 6 percent and a private bond is offered at 10 percent, but with 40 percent of that interest being paid back to the government in taxes, then the overall cost to taxpayers is the same.

Most forms of taxation have a well-documented deadweight loss, resulting from economic distortion. When a tax is levied, it alters both supply and demand in a way that creates general loss of value to society that is greater than the nominal tax rate. If transportation infrastructure were funded through private bonding rather than through general taxation, this deadweight cost — commonly valued at 15 percent — would be avoided entirely. So, the 40-percent portion of the private bond that is paid in taxes would also result in an additional 15-percent value for society in general.

On the opposite side, the tax-deductible depreciation costs of capital investments must also be considered when determining the best deal for taxpayers. As Small states, “Both subsidies and returns to the government are worth more than the amounts of money transferred, presuming that they add to or offset the need for other sources of public revenue that will involve economic distortions.”

We may not know all the answers to these questions. However, it is time for Missouri to consider alternative modes of financing highways and bridges as we attempt to deal with MoDOT’s projected $19 billion shortfall over the next 20 years.

David Stokes is a policy analyst at the Show-Me Institute, a Missouri-based think tank.