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V: PPPs Respond to Transportation Policy Failures

Section III of this report explained that state and local authorities use PPPs to reduce costs, accelerate project delivery, allocate risk more effectively and encourage innovation. These benefits alone, however, do not explain why state and local authorities have been turning to PPPs with greater frequency over the last few years.

The unprecedented use of PPPs described in Section IV is also, in large part, a response to the failings of traditional approaches to transportation funding and procurement. The primary failings include continuous growth in congestion and system unreliability over the last three decades and the difficulty that all levels of government are having satisfying the demand for transportation investment. These failings are exacerbated by the misallocation of transportation resources for political or special purpose spending; by a steadfast reliance on fuel taxes to fund transportation infrastructure despite bipartisan efforts to promote fuel economy, energy independence and reduced emissions; and by lengthy project development cycles which increase costs and make it tougher to respond to priorities.

Recently, for example, a special Transportation Finance Commission established by Massachusetts issued "a call to action," which recommended, among other things, that Massachusetts consider PPPs as an alternative to status quo funding approaches.[87] Explaining the necessity for reform and new sources of revenue, the commission declared that the current system is "frighteningly underfunded and ill prepared to meet the needs of the Commonwealth." The Commonwealth's funding gap was conservatively estimated at $15 billion to $19 billion over the next 20 years. The commission declared that: (i) Massachusetts transportation agencies are running deficits and resorting to quick fixes that hide systemic financial problems; (ii) the condition of Massachusetts' roads, bridges and transit is in broad decline; (iii) revenue is being squeezed from all sides; and (iv) there is no money for improvements without sacrificing existing systems and exacerbating the Commonwealth's problems.[88]

In Idaho, the Idaho Forum on Transportation Investment[89] released a report in January 2006 which identified a $20 billion funding gap over the next 30 years.[90] The group concluded that: "Idaho's current transportation revenue structure will not meet the pressing transportation funding needs over the next 30 years;" that "[i]ncreased transportation funding must be addressed now;" that "[s]olutions to Idaho's transportation funding challenge will require innovative and non-traditional revenue sources and means of collection;" and that "Idaho must recognize the eventual transition from motor fuel (gasoline, diesel, etc.) to alternative fuel vehicles and prepare accordingly."[91] One of the policy recommendations made by the report is to promote partnership opportunities, including PPPs, and remove the legal barriers to PPPs wherever possible.[92] As did the Massachusetts Transportation Finance Commission, the Idaho Forum specifically contrasted its recommendations to explore non-traditional solutions to filling the looming transportation funding gap with the State's current reliance on traditional fuel taxes and a variety of vehicle-related fees to fund its transportation needs, which is not sustainable.

Michigan is the most recent state to launch an investigation exploring alternatives to the current transportation funding system. On December 27, 2007, Michigan Governor Jennifer Granholm approved legislation creating a task force and a citizen's advisory committee to explore alternatives to the current system of funding transportation in Michigan.[93] The task force will consider replacing or supplementing the State's 19-cent gas tax with alternative strategies for funding transportation, including direct user fees. The task force will issue a preliminary report by October 31, 2008 and a final report by April 1, 2009.

The failings of the traditional transportation funding system, which are leading Massachusetts, Idaho and Michigan to search for alternatives, are evident across the United States at all levels of government.[94] PPPs are a preferred alternative because they address these failings.

(1) Poor System Performance: Transportation networks in the United States should provide efficient traffic flow conditions to facilitate the movement of people and goods. The current system for funding transportation, however, does little to directly address congestion and system unreliability, which have steadily gotten worse in urban areas in the United States over the last 25 years. According to the Texas Transportation Institute, the hours of delay per traveler on urban U.S. highways from 1982 to 2005 increased by 171.4 percent, the total hours of delay increased by 425 percent, the total fuel wasted increased by 480 percent, and the total cost of congestion increased by 382.7 percent.[95] At the same time, the total amount spent on highways and transit by all levels of government, Federal, state and local, almost doubled in real terms. For highways, spending increased from approximately $79 billion in 1982 to approximately $134 billion in 2004, and for transit, spending increased from approximately $25 billion in 1982 to approximately $48 billion in 2004.[96] Despite massive investment of public funds, performance continues to deteriorate.

PPPs respond to the poor performance of U.S. transportation systems by providing high-quality, well managed projects that reduce congestion. A recent GAO report indicated that transportation agencies are developing partnerships with the private sector to help fund congestion mitigation techniques, and that "working with private companies can offer a number of benefits for the transportation agency, such as expediting the project schedule, reducing costs, and providing access to private funding sources."[97] The report also asserted that "[p]rivate companies, driven by the need to make a return on investment, are incentivized to manage assets and provide services in efficient ways" and that specific performance standards can be included in concession agreements to ensure that roads are maintained to a specific standard.[98]

PPPs have been trailblazers in the innovative use of direct user fees and variable pricing to reduce congestion. Because direct user fees can be varied to reflect different traffic conditions, pricing can expand capacity by encouraging drivers to use facilities during non-peak periods and to use transit and other transportation alternatives during peak periods.

The first application of variable pricing in the United States, California's SR-91 Express Lanes, was privately financed and designed and constructed through a PPP structure and has been providing a congestion free alternative in Orange County, California, since the project opened in 1995. In a 2004 report to Congress, USDOT stated that during peak-traffic periods each of the two variably priced express lanes in the median of SR-91 was providing throughput for twice as many cars (almost 25 percent of the cars on the road) as each of the four non-priced lanes on SR-91 was providing for (approximately 12 percent of the cars on the road). The report indicated that not only does pricing allow "twice as many vehicles to be served on a lane in the peak hour than the same lane without pricing," but also, "it does so at three to four times the speed on the unpriced lane."[99]

Similarly, the Capital Beltway HOT Lanes project in northern Virginia, which will implement variable pricing on two lanes of an expanded Capital Beltway (I-495), is being financed, designed and constructed and will be operated and maintained, by the private sector through a PPP. In these and other examples private sector innovation and willingness to assume a significant amount of technological, operational and traffic risk reduces congestion and improves system performance.

PPPs are a good fit in congested areas because existing traffic provides comfort that revenues generated by the PPP facility will support the costs of construction, operation and maintenance of the facility and provide a reasonable return on investment. This allows the private sector to finance and assume the risks associated with the development, deployment and operation of traffic-management technology in congested areas, including the risk that variable tolls will maintain a free flow of traffic. Under a traditional approach to project delivery the public sector would have to assume these risks and may have difficulty funding these projects, which can be expensive, even it was willing to do so. From a policy perspective, another important link between PPPs and congestion mitigation is that the public sector stands to gain significantly from the private sector's focus on underperforming facilities. The private sector can gather and analyze large amounts of data with respect to the performance of the Nation's transportation facilities, and this information can help the public sector steer investment towards the facilities that need it most.

(2) Growing Resource Scarcity: In 1956, when the Federal government established the Interstate Highway System and a fuel tax mechanism to fund construction it could hardly have foreseen the difficulties that this funding system would be facing more than a half century later. Following the completion of the Interstate Highway System in the 1970's, political spending and special purpose programs flourished making it more difficult to fund priorities. The fuel tax has come under increasing pressure over the last few decades and non-fuel tax revenues are growing much faster than fuel tax revenues. Today, revenues generated from taxes on fuel represent a minority of all revenues generated for highways and transit-related expenditures. Funding for the operation and maintenance of the transportation system has suffered under a political spending process which struggles to capitalize transportation assets and balance transportation spending with competing needs.

Today, as a result of these and other developments, all levels of government in the United States are having a difficult time keeping up with the demand for transportation investment[100] and are increasingly using transportation related revenues to pay for system preservation and maintenance, with little or nothing left over for new capacity and capital improvements.[101] As noted at the beginning of this Section, individual states are forecasting ominous funding shortfalls. In addition to the funding gaps identified for Massachusetts and Idaho, a report considered by Iowa lawmakers, for example, estimated a $27.7 billion funding gap over the next 20 years,[102] and Texas estimates that it has a funding gap through 2030 of $86 billion.[103] At the Federal level, the U.S. Office of Management and Budget estimated in 2007 that the Highway Account of the Highway Trust Fund would likely see a deficit of $4 billion in 2009.[104]

While transportation investment needs can and should be reduced through more effective pricing[105], better management of the existing system and better investment decision-making, it is increasingly clear that the current model for funding transportation is incapable of adequately responding to the demand for transportation investment.

PPPs provide access to a vast amount of private capital available for investment in transportation. As noted in Section IV(A), a private sector consortium paid an upfront concession payment of $3.8 billion to the Indiana Finance Authority on June 29, 2006, for a concession to operate and maintain the Indiana Toll Road ("ITR") and Indiana used this money to fully fund a 10-year road improvement plan. Similarly, the private sector paid an upfront concession payment of $1.8 billion to the City of Chicago on January 25, 2005, for a concession to operate and maintain the Chicago Skyway. These and other PPPs demonstrate the ability of the private sector to invest significant amounts of private capital in transportation projects. Since 1985, $415 billion worth of transportation PPP projects have been put under construction or completed around the world, and transportation PPP projects worth $572 billion were in a pre-construction phase as of October 1, 2007.[106] The two companies that invested equity in the Chicago Skyway and the ITR, Macquarie Group and Ferrovial-Cintra, had approximately $44 billion and $38 billion invested in transportation infrastructure around the world, respectively, as of October 2007.[107] In addition to the Chicago Skyway and ITR, Macquarie has made investments in the Dulles Greenway in Virginia and the South Bay Expressway in California, and Cintra recently closed a concession for the $1.36 billion SH-130 Segments 5&6 Project in Texas.

A significant portion of the capital that is available for investment in transportation projects is managed by private infrastructure funds and pension funds. Private infrastructure funds looking to invest in U.S. transportation infrastructure include funds managed by Goldman Sachs, the Carlyle Group, JP Morgan, Citigroup, GE and Credit Suisse, Morgan Stanley, Merrill Lynch, Babcock & Brown, Macquarie and others.[108] CalPERS, the largest public pension fund in the United States , approved a $2.5 billion pilot infrastructure investment program in 2007.[109] Funds have raised billions of dollars for investment in infrastructure projects, and a significant amount is expected to be invested in stable western countries like the United States. Infrastructure projects are attractive because the steady, long-term earnings generated by these projects, while lower than that of other private equity investments, match the liabilities of long-term, low-risk investors.

The Financial Times reported at the end of 2007 that "estimates of equity already raised for infrastructure investment but not yet invested range from $50 billion to $150 billion."[110] The McKinsey Quarterly in February 2008 reported that the world's 20 largest infrastructure funds now have nearly $130 billion under management, 77 percent of which was raised in 2006 and 2007.[111] The McKinsey Quarterly noted that in some situations $1 billion of equity could be leveraged to pay for as much as $10 billion in projects. Even assuming more conservative leveraging, the equity available for investment could help pay for several hundred billion dollars worth of infrastructure projects. The ability of the private sector to invest large amounts of private capital in transportation projects can provide significant relief to the public sector in its efforts to keep up with the demand for transportation investment in the United States.

(3) Poor Investment Decision-Making: The difficulty that the current transportation funding system has responding to the demand for transportation investment is aggravated by the political processes that dictate how transportation investments are made. Ideally, transportation revenue should be allocated to high priority projects for which research indicates that benefits outweigh costs and that the public sector is going to get a valuable return for every dollar invested. Revenues from transportation-related taxes and fees, however, are often deposited in public trust funds and allocated to particular projects through a political process, without any analysis of the projects' underlying economic merits or adequate consideration of the taxpayers' potential exposure.

Political earmarks exemplify the misallocation of resources under the current system of transportation funding. The number of earmarks in Federal highway and transit authorization bills exploded from 10 in the 1982 bill to more than 6,000 in the 2005 bill.[112] Not all earmarks are wasteful. Some, like transportation funding generally, are used for necessary projects that are included in state or local transportation plans. Nevertheless, there is no mechanism in place to ensure that all or even a substantial number of earmarks are based on a project's underlying merits, economic or otherwise. In addition, because Federal earmarks are often inconsistent with state or local transportation plans, many earmarks languish, unspent, while high-priority projects may be delayed or cancelled for lack of funding.[113]

Unfortunately, the lack of economic analysis is not limited to the earmarking process; it pervades many parts of the current transportation funding system. A recent report from the GAO indicated "that many state and local transportation agencies are not consistently using formal economic analysis as part of their investment decision-making process to evaluate project alternatives."[114] GAO noted that "political concerns" play a role in limiting the expansion of formal economic analysis of investment decision making[115], but also leveled responsibility on the current system of formulas used to allocate Federal highway funding, which does not include any requirements that a project have economic merits.[116] GAO also reported that the actual outcome of a project is rarely assessed to determine whether an investment was in fact valuable or whether it failed to provide economically justifiable benefits.[117] This lack of economic analysis helps explain why rates of return on public highway investments have plummeted in recent years; according to one estimate, from more than 15 percent in the 1970's to less than 5 percent in the 1990's.[118]

PPPs can reduce the wasteful effects of political and special purpose spending because private investment is research-based and follows demand, not political influence. Because private investors typically look to the revenues generated by a project to repay debt and equity investments, they have significant incentive to ensure that the cost and performance forecasts for projects, on which the build-decision is based, have a high probability of accuracy. In addition, as noted in Section III, because private companies are accountable to their shareholders and financially liable to counterparties and financiers they have significant incentive to avoid cost overruns. A decision to invest funds in a PPP is only made by the private sector after a careful consideration of the project's underlying value and expected costs and benefits.

The substantial incentive for the private sector to understand and control a project's costs and benefits compares favorably with the past performance of many government grant recipients. For example, in 2003 the Federal Transit Administration ("FTA") studied the predicted and actual costs and benefits of several major transit projects implemented in the past two decades using Federal funds. The actual as-built capital costs of 16 of the 21 projects studied were greater than the forecasted costs by an average of 20.9 percent.[119] Only three of the 19 projects studied had achieved their forecasted ridership at the time of the study. In a report prepared for FTA in 1990, none of the ten projects studied had achieved forecasted ridership and only one was carrying more than 50 percent of forecasted ridership.[120]

FTA implemented its Public-Private Partnership Pilot Program ("Penta-P") in January 2007 to "study the proposition that when risks associated with new construction are appropriately allocated between a project sponsor and its private partner, FTA may rely on the commercial due diligence, financial incentives, and potential liabilities of the private partner to control for such risks."[121] Through the Penta-P, FTA is studying whether commercial due diligence of proposed transit mega projects clarifies their costs and benefits better than conventional due diligence, and thereby improves the build-decisions. A business-oriented investment model can reduce the wasteful effects of political and special purpose spending and help ensure that the traveling public gets cost-effective and valuable projects.

A recent report comparing the performance in Australia of 21 PPP projects and 33 traditional projects concluded that PPPs demonstrate "clearly superior cost-efficiency" over traditional procurement methods.[122] The report indicated that for $4 billion of traditional projects the net cost over-run was $602 million, while for $4.4 billion of PPP projects the net cost over-run was only $52 million, which was not considered statistically different from zero. The report also indicated that while traditional procurements were completed 23.5 percent behind schedule, PPPs were completed, on average, 3.4 percent ahead of schedule.

A survey of 37 PPP projects in the United Kingdom confirmed that the private sector is more reliable than the public sector when it comes to completing projects on time and on budget. The report revealed that while 73 percent of traditional public sector projects resulted in construction costs exceeding the price agreed at time of contract, only 22 percent of the projects procured as PPPs resulted in construction costs exceeding the price agreed at time of contract, and that in these cases the price increase was due to changes requested by the public sector not through the fault of the concessionaire.[123] The report also revealed that while 24 percent of the projects procured as PPPs were delivered late, only 8 percent of these projects were delivered more than 2 months late, which compared favorably with traditional public sector projects which were delivered late 70 percent of the time.[124]

(4) Contradictory Policy Goals: A highway funding model that relies on fuel tax revenues becomes increasingly untenable as the United States moves towards increased energy independence, greater fuel economy in automobiles, development of alternative fuels, and reduced emissions. Trends show that hybrid vehicles are becoming increasingly popular based on concerns about oil supply, fuel prices and emissions[125] and that consumers are driving fewer miles.[126] On December 19, 2007, President Bush signed legislation requiring new auto fleets to average 35 miles a gallon by 2020, a 40 percent increase from today's 25-mile average.[127] These trends presage reductions in the amount of fuel tax revenue available for investment in transportation, which will make it more difficult to respond to the demand for investment. As the United States strives to reduce its dependence on foreign oil and to encourage greater use of alternative energy sources, a transportation funding system that relies primarily on fuel taxes undoubtedly contradicts the Nation's overall policy objectives.

PPPs address concerns that fuel taxes are not a viable revenue source by substituting private capital and direct user fees for fuel tax revenue. Over the next few years, infusions of private capital can supplement efforts to shore up the uncertain balances of the Federal Highway Trust Fund so that transportation projects can be funded. Perhaps more importantly, private capital and direct user fees are not subject to the same political and market forces that are expected to deteriorate the value of fuel taxes over the next several years.

Political and public sentiment increasingly supports the use of tolls and other direct user fees rather than fuel taxes. A May 2007 report from the Reason Foundation reported that polls conducted around the United States clearly demonstrate that a majority find it preferable and more fair to fund transportation with tolls rather than with increases in fuel taxes.[128] For example, a recent survey conducted by the American Automobile Association found that more than half of the respondents favor tolls while only 21 percent favor fuel taxes.

As questions about the short- and long-term viability of fuel taxes intensify, private capital and direct user fees are proving to be advantageous alternatives.

(5) Lengthy Development Cycles: It often takes more than 13 years to advance a major project from concept to completion.[129] The New York Times recently highlighted this problem by reporting that a project to widen a congestion-burdened bridge in New Haven, Connecticut, will take 14 years to complete and that after six years of work the first pilings for the bridge improvements have yet to be sunk.[130] Project delays increase overall costs and project sponsors are forced to either spend more money to complete the project or to abandon the project. Delays are only made worse by the precipitous increase in construction costs that the United States has experienced over the last few years. From 2003 to 2006, the Federal Highway Administration Bid Price Index increased 47.7 percent and the Bureau of Labor Statistics bridge and highway producer price index increased 35.3 percent, in each case more than 3 times greater than the largest increase over any other 3-year span since 1990. During the same period, CPI increased by only 9.6 percent and the producer price index for all commodities increased by 19.3 percent.[131] In this cost environment speed of delivery is critical. The total cost of the Louisville/Southern Indiana Ohio River Bridges Project, for example, increased from approximately $2.5 billion in 2003 to $4.1 billion in 2007, in large part because the costs of construction increased from approximately $2.0 billion to $3.6 billion during this time period.

While lengthy development cycles are caused by multiple factors, not just funding gaps, PPPs can help accelerate project delivery. As noted in Section III, the efficiencies created by combining multiple project elements in one private partner accelerate project delivery. PPPs can also speed up a project by providing upfront capital to cover all of a project's costs. Fuel taxes and other traditional sources of revenue are spent on a pay as you go basis as they are collected and allocated. This process can cause delays if funds aren't available as needed. Tax-exempt government debt allows the public sector to borrow the full cost of a project upfront, but states and local entities typically have limited capacity to issue debt and can only leverage so many projects at one time. PPPs enable the private sector to issue project debt and assume the financing risks, which allows the public sector to reap the benefits of a leveraged project without burdening its balance sheets.

The problem of lengthy project schedules is especially acute for large, expensive projects that will require several years to complete even if all of the funding is available upfront. These projects can be difficult to finance with public debt because they chew up too much of the public sector's debt capacity. These projects are also difficult to undertake on a pay as you go basis because of concerns about cost and schedule overruns. While the private sector can help make these projects viable by providing upfront capital and assuming the debt, the private sector also facilitates these projects by assuming the risk of cost and schedule overruns. Outside of certain circumstances (such as design changes requested by the public agency) the private sector typically assumes the risks of cost and schedule overruns in a PPP. Price and schedule predictability gives the public sector comfort that it will not need to contribute more funding to an expensive project that is experiencing cost overruns or delays, and also allows the public sector to use other resources more effectively.

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