Turning for profit

July 18, 2005

Roads in America have been distinctly “non-profit” for the last three decades. The accumulated financial losses are disguised by the fragmented and dispersed financial reporting of federal, state and local governments. This leaves public highway officials in a difficult situation when they then attempt to persuade legislators to boost tax rates to fund highways. Detailed enumerations of specific projects to be built are often derided as mere “wish lists.”

Roads in America have been distinctly “non-profit” for the last three decades. The accumulated financial losses are disguised by the fragmented and dispersed financial reporting of federal, state and local governments. This leaves public highway officials in a difficult situation when they then attempt to persuade legislators to boost tax rates to fund highways. Detailed enumerations of specific projects to be built are often derided as mere “wish lists.”

Consequently, roads tend to be neglected. Roads are long-lived assets. It may take decades before wear-and-tear becomes perceptible. By then the damage is liable to be severe.

It doesn’t have to be this way. Roads are extremely productive assets. The value they provide for users is huge. Roads can and should be treated as profit-making assets. Economics provides the motive for doing so and modern technology provides the means for a conversion from a financially ill public ownership to a healthy private ownership.

Use is cheap

Poor financial condition is usually a sign that the demand for the product is in decline. There is little evidence that this is the case with highways. Since the mid-1960s, vehicle registrations in the U.S. have gone from 90 million to over 200 million. Highway travel has risen from around 900 billion to 3 trillion vehicle miles. It is clear that driving is popular. Motor vehicles give people what they want: speed, comfort, convenience and affordability. Almost none of this travel would be possible and these motorized vehicles would be nearly worthless without roads. Yet, investment in roads in the U.S. seems inadequate to cope with peak-period surges in traffic volume or the long-term wear-and-tear of the road surfaces.

We can get an inkling of the value of the road system by attempting to estimate the value of highway transportation as perceived by users in the decisions they make. A “consumer choice” model assumes that the amount of money consumers voluntarily pay to use a product represents a minimum value for that product. In most commercial transactions, the sales revenue obtained from customers serves as the best estimate of this minimum value. For highways, we lack direct sales data.

To resolve the difficulty we can consider the complementary package of services represented by the combined amounts paid by consumers for both the vehicle and the road. This is justified because consumers wouldn’t be buying cars if there were no roads on which to drive. Likewise, trucking businesses would have no revenues if there were no roads on which to carry out their business.

The combined weighted-average value per vehicle mile of travel for trucks and cars is approximately 33 cents. This 33 cents per vehicle mile of travel value estimate for combined truck and car travel includes all taxes paid for the construction and upkeep of highways. As those familiar with highway finance know, though, the share of the 33-cent total that is available for construction and upkeep of the roads is only 3.3 cents per vehicle mile of travel.

Given the qualitative and quantitative evidence of the value of the vehicle-highway combination, the logical conclusion is that the demand for roads is high. Road users likely would be willing to pay considerably more than the 3.3 cents per mile. That road users don’t pay more can be attributed to the fact that the roads are run by government agencies that lack both the incentive and authority to implement appropriate user fees to support roadway investment.

In the loss column

We should evaluate highway investments on the same basis that private-sector businesses evaluate investment decisions. Just like the private sector, our costs will be the expenditures we must make building, improving and maintaining our assets. Our revenues will be the fees paid by our customers for the use of the roads.

Using a profit/loss analysis, we find that roads in the U.S. have been operating at a loss for quite some time. An illustration of the financial position is provided by the accompanying graph of a “profit-and-loss” statement for the U.S. roadway system.

On an inflation-adjusted basis (i.e., accounting for the fact that worn out or obsolete facilities will have to be repaired or replaced at much higher cost than is allotted for in the depreciation schedule), the deficits were even worse. On an inflation-adjusted basis, the U.S. roadways have earned nearly $400 billion less than what would have been needed to make the roads a “break-even” proposition.

Make a mature decision

To many the idea of the private sector owning and operating roads is implausible. Yet, historical precedent exists. From 1790 to 1830 more than 10,000 miles of roadways were financed and built by the private sector. Highway privatization statutes exist in at least five states: Arizona, California, Florida, Texas and Virginia. There are privately owned and operated highways in California and Virginia.

All of these privatization statutes are designed to provide new facilities. This approach has the political advantage of not tampering with existing roadways. Since drivers would not be losing any privileges, opposition from highway users may be muted. A disadvantage of restricting privatization to the construction of new facilities, though, is the high level of financial risk. New highways have no established base of traffic. Further, privatized facilities may face competition from “free” (tax-funded) roads operated by government authorities.

A less risky approach would entail privatizing existing highways. These more mature assets have an established traffic pattern. While this pattern would be affected by the addition of tolls, the resulting traffic volumes are apt to be more predictable than they are for new routes.

Many are vexed by apparent technical difficulties with privatization. They are persuaded that toll collecting is cumbersome and time consuming. Fortunately, this vision of lines of vehicles waiting to pay tolls is more a glance backward than at the future. Modern technology makes it possible for vehicles to be equipped with low-cost transponders that allow tolls to be paid while moving at full speed. This automated toll-collection technology has been demonstrated on numerous highways including facilities located in Atlanta, Dallas, Denver, Houston, Miami, New Orleans, New York, New Jersey, Illinois and Oklahoma.

While it is possible for these benefits to be achieved in the public sector, it is unlikely that the public sector could progress as far or as fast as the private sector could. In the private marketplace being first or the best means bigger profits. This inspires risk taking and innovation in pursuit of profits. Effective privatization of state highways might be implemented via the following steps:

  • A phased program with a percentage of the existing public-sector highway mileage being “auctioned off” each year;
  • A matching phased reduction of highway users’ taxes;
  • Adoption of a nationwide automated tolling technology standard;
  • In-state registered vehicles could be issued transponders with their license tags. Toll transponders would need to be made available on a deposit basis at convenient locations for travelers from out-of-state;
  • For the first half of the program, private-sector businesses should be allowed to bid on any routes;
  • For the second half of the program, the public sector would identify the remaining route segments to be auctioned off. In some cases, lightly used route segments might have to be given away to abutting property owners;
  • Users of privatized route segments should be entitled to refunds of user taxes based on the mileage driven on these private-road segments;
  • Proceeds from the sale of road segments should be used to retire highway agency debt;
  • To encourage competition, private-sector bidders should be barred from owning immediately parallel routes; and
  • County and city governments should be encouraged to participate. In any case, the incentive to participate would be inspired by the phase out of statewide highway user taxes.

Boast the benefits

Fear of change can be expected to generate dire prognostications of disaster from so different a means of providing for roads. This could be countered by marketing the benefits of the proposed change to the highway users. A key element of this marketing effort would be an emphasis that the proposal would replace existing taxes with user-based fees. This would counter the fear that the plan was just a stratagem for extracting more money. A second element of the marketing effort would be to highlight the advantages of being a customer as opposed to merely a taxpayer. In the marketplace, a customer is always right. The government extends no equivalent reverence for a taxpayer.

Another potential obstacle is the average person’s unfamiliarity with how an electronically priced road system would work. It is commonly believed that making users pay directly for roads would require time-consuming toll collection procedures. Demonstrating modern electronic road-pricing technology at work would be a means of overcoming this obstacle.

This glowing picture of the benefits of privatization should not be taken as a sign that the transition to a new way of operating transportation facilities would be easy. There are many policy issues to be confronted and decisions to be made. The forces of inertia always work against change. Nevertheless, the well-traveled road of traditional public sector ownership and control of transportation assets leads to a dead end. Getting off of this dead-end road, difficult as it may be, is necessary if improvement of transportation systems is desired.

About The Author: Semmens is a project manager for the Arizona Department of Transportation, Phoenix. His views do not represent the official policy of AzDOT.