Want To Pay Higher Prices with Lower Quality? Privatize!

Toll Road Privatization: As Ohio Considers It, Indiana Serves As A Cautionary Tale

By Dave Jamieson

what can’t be denied is that the road is getting more expensive to travel on. And no one knows how expensive it might get … Over the course of the coming decades, Hoosiers can expect to learn a hard lesson in compound interest, long after Gov. Daniels is gone.

WASHINGTON — In two weeks, the cost of traveling the 157-mile length of the Indiana Toll Road will rise more than 2 percent, from $8.80 to an even $9, for those who pay the toll in cash. The fare will jump a full buck for truckers hauling semi-trailers, from $35.20 to $36.20.

The July 1 toll hike may not seem so painful, until you consider that those tolls were about half of their soon-to-be rates only five years ago — and that they hadn’t risen for two decades prior to that. Even harder to swallow for some drivers, truckers in particular, is the fact that their growing contributions go not to the State of Indiana but to overseas investors who’ve leased the toll road from the state.

“Saying we’re less than thrilled would put it really mildly,” says Todd Spencer, executive vice president at the Owner-Operator Independent Drivers Association, a trade group that represents truckers. “In Indiana, over the span of a few years, we’ve watched truck tolls more than double.”

In 2006, under the orchestration of Gov. Mitch Daniels (R), the state struck a deal to lease the road for a period of 75 years to Australia-based Macquarie Group and Spain-based Cintra. The investors paid the state $3.8 billion upfront in exchange for the right to collect tolls. The investors are required to maintain and upgrade the road for the duration of the lease.

It’s still too early to tell how good or how rotten a deal the state got. In fact, there are those who believe Macquarie and Cintra may have greatly overpaid for the highway, and Daniels himself has gloated that the arrangement was “the best deal since Manhattan was sold for beads.” (Daniels’ office did not respond to questions about the deal.)

But what can’t be denied is that the road is getting more expensive to travel on. And no one knows how expensive it might get. (So far the rates have not been raised on drivers with transponders, but that will change in 2016, when those drivers will start paying the cash rates.) The road’s leaseholders can now raise the toll annually at one of three rates — at a flat two percent, at the percentage increase in the consumer price index or at the percentage increase in gross domestic product — whichever is highest. Over the course of the coming decades, Hoosiers can expect to learn a hard lesson in compound interest, long after Gov. Daniels is gone.

“I think they’re going to regret promising the toll road operators that they could do that,” says Jose Gomez-Ibanez, a professor in public policy at Harvard’s Kennedy School of Government who’s studied road privatization for years.

Such is the bargain some cash-strapped states are willing to make in order to mortgage their infrastructural assets. Whether it’s parking meters, government buildings or highways, privatization deals look awfully tempting these days, with state budgets strained to the breaking point and many Republican-leaning states in an anti-government fervor. These long-term deals can provide sitting politicians with an immediate windfall, but they can place a considerable burden on taxpayers two or three generations from now.

We’re likely to see more of these deals made in the future. In its most recent annual report, investment bank Goldman Sachs noted that “recent market conditions may lead to an increase in opportunities to acquire distressed assets,” such as toll roads, airports and shipping ports. Such deals, the report went on, “expose us to new and enhanced risks,” including “greater regulatory scrutiny” and “reputational concerns with the manner in which these assets are being operated or held.” The public wouldn’t want to get gouged at the tollbooth — and certainly not by Goldman Sachs.

“If you want to cast a broad brush, you would say that leasing an existing asset is essentially the most problematic use of privatization,” says Oregon Rep. Peter DeFazio (D), a senior member of the House Transportation and Infrastructure Committee. “Look how desperate some states are, leasing their lotteries. It’s pretty short-sighted. One of the most basic things government does after public safety and law enforcement is infrastructure, and we’ve known that since the first Congress.” DeFazio described toll-road privatization as the “outsourcing [of] political will” in a 2007 Mother Jones story probing the Indiana deal, since it leaves to private companies a duty that few politicians have the courage to do: raise tolls.

Although former Pennsylvania Gov. Ed Rendell (D) never saw the Pennsylvania Turnpike privatized like he’d hoped, in recent months Ohio Gov. John Kasich has voiced his support for leasing the Ohio Turnpike and its future tolls to investors for $3 billion, which, after writing down some $600 million in debt, would leave the state with a $2.4 billion payday.

“I can take that money and I can put a billion dollars in infrastructure,” Kasich said earlier this year, according to the Cleveland Plain Dealer. “Wouldn’t that be fantastic, instead of having an asset that is underutilized in the state at a time when we are in a crisis? I think so.”

What Kasich would like to undertake is often called an “asset monetization” project, wherein a government leverages an existing asset expressly to tap private capital markets. Ibanez-Gomez, for one, believes road privatization projects can be done well, but he tends to get uncomfortable when politicians like Kasich seem to have no motive other than to essentially borrow lots of money.

Much of the public, too, tends to squirm when we talk about leasing long-held government assets under contracts that span the better part of a century. Kasich’s musings haven’t escaped Ohio Congressman Tim Ryan (D), who believes leasing the Ohio Turnpike long-term could be disastrous.

“I think it’s a bad idea,” Ryan says. “It’s a quality roadway, and I think we really risk an increase in tolls and a decrease in quality if this thing gets privatized…. To me it’s another example of pure ideology, where everything that government does needs to be abolished or privatized.”

The private sector may or may not manage highways better than state governments, but it’s certainly better at inking favorable contracts. Despite Daniels’ excitement for his toll road lease, the Indiana deal offers a few cautionary tales beyond rising toll rates. Phineas Baxandall, an expert in privatization at U.S. PIRG, a federation of public-interest research groups, says the Indiana contract runs about 600 pages long, and even though such deals are meant to shift risk away from the state and toward private entities, “most of it is about protecting the investor from risks,” he says.

Indiana has already learned about the downside of deals with so-called “compensation events” and “adverse-action” clauses. If something unforeseen occurs that cuts against the investors’ expected returns, the state may wind up compensating the investors. For instance, when fees on the toll road were temporarily waived for safety reasons during a serious flood in 2008, the state ended up reimbursing the toll operators for lost revenue. Had the state not leased the road, the waiver would have cost it nothing.

“It means that what would normally be good public policy decisions have to be weighed against the financial penalties that the public and taxpayers have for doing it,” says Baxandall.

In other words, by handing a previously government-owned asset over to private investors, the state has relinquished some of its democratic power to act freely in the public interest along the toll road’s corridor. The same premise applies to non-compete clauses in the contract. If the state wanted to build or improve other roads within ten miles of the toll road, for instance, it could be forced to pay the toll road’s leaseholders for the privilege to do so, per the contract.

Penn State Law professor Ellen Dannin says such investor protections are common in infrastructure privatization deals, and she believes they end up tilting the playing field toward the investors.

“When you look at these adverse-action clauses, the U.S. looks much more like a sub-Saharan Africa country than [a developed] country,” she says. “Those adverse-action clauses go on for pages and pages. They’re putting the contractor in a better situation than the government would be.”

What’s good for the public isn’t necessarily what’s good for investors, and that’s what worries Dannin and others about highway privatization deals, whether it’s the leasing of existing roadways or the building of new roadways financed by private groups.

In the suburbs of Washington, D.C., Virginia is partnering with private investors to develop “high occupancy toll” or HOT lanes on the Capital Beltway and Interstate 95. Commuters who ride at least three-to-a-car or ride the bus won’t have to pay a toll, while less efficient commuters will have to pay to ride in the fast lane. But under that arrangement, the road operators have little incentive to encourage commuters to carpool for free or to start riding the bus, although many of us would consider such developments to be in the greater common good. Improvements such as a parallel train line or more bus lines could even be seen as adverse actions hurting investors’ bottom line.

“You’re guaranteeing a certain amount of revenue for a long period of time, and that constrains future generations from having the option to make different choices,” says David Alpert, a transit expert and influential Washington-area blogger. Alpert says the state could wind up on the hook covering investors’ revenue shortfalls. “It’s a really dangerous provision,” he says, especially considering the length of the lease: 80 years on the Beltway.

Why are these leases typically so long? It probably has a lot to do with tax breaks. When an asset is leased for a period longer than its reasonable life expectancy — and highways typically have a life span of about 45 years — the investors can write off the asset’s depreciation.

“It’s like a free loan in tax credits,” Baxandall says. “That’s what’s really galling about these hidden subsidies. The whole rationale for doing these deals is they’re supposed to save the pubic money. If the public has to subsidize these deals, it defeats the purpose.”

And unfortunately, it’s nearly impossible to know what a smart transportation project might look like in 50 or 75 years — high-speed rail set on a turnpike median, for instance — and contracts with private leaseholders could end up hamstringing jurisdictions that want to go in new directions.

Still, Robert Poole, director of transportation policy at the free-market Reason Foundation, says there can be great benefits to privately financing toll roads, especially new roads that need to be built. In the best-case scenario, says Poole, the high risks are transferred to investors, “a very important benefit almost never appreciated by the general media or a lot of elected officials.” Poole says that even in the case of Ohio, leasing the existing tollway should be considered an option.

“I look at the Ohio Turnpike,” says Poole, “and I see a road that will need major reconstruction in the next decade or two…. Given that the toll road industry has a very good track record of financing and building, I think [privatization] is an acceptable alternative to look at.”

In April Kasich’s transportation director went on a tour of northwest Ohio to discuss with local leaders the possibility of leasing the turnpike, saying that the proposal process could take anywhere from six to 18 months, according to the Toledo Blade. Kasich has said in the past that if the deal didn’t look favorable, the state wouldn’t pursue it. But considering the deteriorating financial outlook of Ohio and most other states, privatization will only look sweeter. Rep. Ryan, for one, believes such a lease will happen if Kasich so desires.

“The governor has pretty much gotten everything he’s wanted up to this point,” Ryan says. “If he wants to muscle this thing through, he’d be able to do that.”

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